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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended Commission File
December 31, 2003 No. 1-8019
PROVIDENT FINANCIAL GROUP, INC.
Incorporated Under IRS Employer I.D.
the Laws of Ohio No. 31-0982792
One East Fourth Street, Cincinnati, Ohio 45202
Phone: 1-800-851-9521 or 513-345-7102
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: Common Stock,
Without Par
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and need not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]
As of February 27, 2004, there were 49,195,045 shares of the Registrant's
Common Stock outstanding. The aggregate market value of the Common Stock held by
non-affiliates at June 30, 2003, was approximately $709,698,000 (based upon
non-affiliated holdings of 27,561,000 shares and a market price of $25.75 per
share).
DOCUMENTS INCORPORATED BY REFERENCE:
None
Please address all correspondence to:
Christopher J. Carey
Executive Vice President and Chief Financial Officer
Provident Financial Group, Inc.
One East Fourth Street
Cincinnati, Ohio 45202
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
INDEX TO ANNUAL REPORT
ON FORM 10-K
PART I
ITEM 1. BUSINESS .................................................... 1
ITEM 2. PROPERTIES .................................................. 4
ITEM 3. LEGAL PROCEEDINGS ........................................... 4
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ......... 5
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES ........... 5
ITEM 6. SELECTED FINANCIAL DATA ..................................... 6
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS .................................... 7
FINANCIAL CONDITION ......................................22
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL
OBLIGATIONS...............................................34
CAPITAL RESOURCES ........................................40
CRITICAL ACCOUNTING POLICIES .............................41
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ..44
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA .................45
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE .........................93
ITEM 9A. CONTROLS AND PROCEDURES .....................................93
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ..........93
ITEM 11. EXECUTIVE COMPENSATION ......................................96
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS .............103
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS .............107
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES......................108
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
ON FORM 8-K ................................................109
SIGNATURES ..............................................................114
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
FORWARD-LOOKING STATEMENTS
This Form 10-K contains certain forward-looking statements that are subject to
numerous assumptions, risks or uncertainties. The Private Securities Litigation
Reform Act of 1995 provides a safe harbor for forward-looking statements.
Forward-looking statements may be identified by words such as estimates,
anticipates, projects, plans, expects, intends, believes, should and similar
expressions and by the context in which they are used. Such statements are based
upon current expectations of the Company and speak only as of the date made.
Actual results could differ materially from those contained in or implied by
such forward-looking statements for a variety of factors including: sharp and/or
rapid changes in interest rates; significant changes in the anticipated economic
scenario which could materially change anticipated credit quality trends;
changes by rating agencies in Provident's debt rating; the ability to generate
loans and leases; significant cost, delay in, or ability to execute strategic
initiatives designed to grow revenues and/or manage expenses; consummation of
significant business combinations or divestitures; and significant changes in
accounting, tax, or regulatory practices or requirements and factors noted in
connection with forward-looking statements. Additionally, borrowers could suffer
unanticipated losses without regard to general economic conditions. The result
of these and other factors could cause differences from expectations in the
level of defaults, changes in risk characteristics of the loan and lease
portfolio, and changes in the provision for loan and lease losses. Provident
undertakes no obligations to update any forward-looking statements to reflect
events or circumstances arising after the date on which they are made.
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
PART I
ITEM 1. BUSINESS
Provident Financial Group, Inc.
Provident Financial Group, Inc. (Provident) is a Cincinnati-based commercial
banking and financial services company. At December 31, 2003, Provident had
total assets of $17.0 billion, loans and leases of $8.9 billion, deposits of
$10.3 billion and shareholders' equity of $899 million. Additionally, Provident
services loans and leases for other entities including $1.3 billion which have
been securitized (off-balance sheet managed assets); $3.8 billion which have
been sold by a wholly-owned subsidiary through the Fannie Mae DUS program as an
approved seller/servicer; and $16.0 billion which have no recourse to Provident.
Provident's executive offices are located at One East Fourth Street, Cincinnati,
Ohio 45202 and its Investor Relations telephone number is (513) 345-7102 or
(800) 851-9521. The Annual Report, on Form 10-K, is filed with the Securities
and Exchange Commission (SEC). Copies of this document and all other SEC filings
by Provident may be obtained, without charge, by contacting Investor Relations.
These reports may also be obtained via the Internet at the web sites of
Provident at http://www.providentbank.com, or the SEC at http://www.sec.gov.
Provident has 65 full service branch banking centers located in Ohio and
Kentucky. Provident also provides commercial financing, equipment leasing and
mortgage lending at a national level with commercial lending offices located in
eleven states. During the fourth quarter of 2003, Provident sold its 13 Florida
branches along with certain deposits and loans to RBC Centura Bank, a subsidiary
of Royal Bank of Canada.
Provident conducts its banking operations through The Provident Bank. Major
business lines are Commercial Banking, Retail Banking and Mortgage Banking. See
ITEM 7 "Management's Discussion and Analysis of Financial Condition and Results
of Operations - Business Lines" and Note 21 included in "Notes to Consolidated
Financial Statements" for details as to the types of financial products and
services offered by these business lines.
At December 31, 2003, Provident and its subsidiaries employed approximately
3,200 full-time-equivalent employees.
Subsequent Event
On February 17, 2004, Provident announced that it had signed a definitive
agreement to merge with National City Corporation. National City Corporation is
a financial holding company headquartered in Cleveland, Ohio. Under terms of the
agreement, Provident shareholders will receive 1.135 shares of National City
Corporation common stock for each share of Provident common stock in a tax-free
exchange. Subject to regulatory and stockholder approvals, the transaction is
expected to close in the second quarter of 2004.
1
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
Competition
The financial services business is highly competitive with many products and
services priced on a commodity basis. Provident competes actively with both
national and state chartered banks, savings and loan associations, securities
dealers, mortgage bankers, finance companies and other financial service
entities.
Supervision and Regulation
Provident is registered as a bank holding company, and is subject to regulations
of the Board of Governors of the Federal Reserve System (Federal Reserve) under
the Bank Holding Company Act of 1956 (the BHC Act), as amended. Bank holding
companies are required to file periodic reports with and are subject to
examination by the Federal Reserve. The BHC Act requires Federal Reserve
approval of acquisitions of control of more than 5% of the voting stock or
substantially all of the assets of any bank or bank holding company. The BHC Act
authorizes interstate bank acquisitions anywhere in the country and allows
interstate branching by acquisition and consolidation in those states that have
not opted out. Ohio and Kentucky did not opt out of interstate branching.
Provident is prohibited by the BHC Act from engaging in nonbanking activities,
unless such activities are determined by the Federal Reserve to be financial in
nature, incidental to such financial activity, or complementary to a financial
activity. The BHC Act does not place territorial restrictions on such
nonbanking-related activities.
The Sarbanes-Oxley Act, enacted by Congress in 2002, mandates a variety of
corporate governance and financial reporting requirements intended to enhance
the accuracy and transparency of public companies' financial reports. It
established new responsibilities for corporate Chief Executive Officers, Chief
Financial Officers and audit committees in the financial reporting process.
Among other major issues in Sarbanes-Oxley, Provident's Chief Executive Officer
and Chief Financial Officer are each required to certify that Provident's
quarterly and annual reports do not contain any known untrue statements of a
material fact. More information about Provident's corporate governance practices
is available on the Investor Relations page of the corporate web site at
http://www.providentbank.com.
The Gramm-Leach-Bliley Act, which was enacted on November 12, 1999, imposes
privacy disclosure and "opt out" requirements on virtually all regulated
financial services organizations.
The Financial Institutions Reform, Recovery and Enforcement Act of 1989 provides
that a holding company's controlled insured depository institutions can be held
liable for any loss incurred by, or reasonably expected to be incurred by, the
Federal Deposit Insurance Corporation (FDIC) in connection with the default of
an affiliated insured bank or savings association.
Provident's subsidiary bank, The Provident Bank, an Ohio state-chartered member
bank of the Federal Reserve System, and its subsidiaries are subject to
supervision and examination by applicable federal and state banking agencies,
including the Federal Reserve, FDIC and the Ohio Division of Financial
Institutions. One aspect of this supervision is that there are various legal and
regulatory limits on the extent to which The Provident Bank may pay dividends or
otherwise supply funds to Provident. In addition, federal and state regulatory
agencies also have the authority to prevent a
2
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
bank or bank holding company from paying a dividend or engaging in any other
activity that, in the opinion of the agency, would constitute an unsafe or
unsound practice. See ITEM 7 "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity" and Note 25 included in "Notes
to Consolidated Financial Statements."
Federal and state laws regulate other aspects of the operations of The Provident
Bank, including requiring the maintenance of cash balances against deposits,
limiting the nature of loans and interest that may be charged thereon, and
restricting investments and other activities.
As a regulated financial services firm, Provident's relationships and good
standing with its regulators are of fundamental importance to the continuation
and growth of Provident's businesses. The Federal Reserve, the FDIC, the Ohio
Division of Financial Institutions, and other regulators have broad enforcement
powers, and powers to approve, deny, or refuse to act upon applications or
notices of Provident or its subsidiaries to conduct new activities, acquire or
divest businesses or assets or reconfigure existing operations. Provident and
its subsidiaries are subject to examination by various regulators which results
in examination reports and ratings (which are not publicly available pursuant to
regulatory rules) that can impact the conduct and growth of Provident's
businesses. These examinations consider not only compliance with applicable laws
and regulations, but also capital levels, asset quality and risk, management
ability and performance, earnings, liquidity, and various other factors. The
ratings are largely at the discretion of the regulator and involve many
qualitative judgments that are not as a practical matter subject to review or
appeal.
State and federal banking agencies possess broad powers to take corrective
action as deemed appropriate for an insured depository institution and its
holding company. The extent of these powers depends upon whether the institution
in question is considered "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" or "critically
undercapitalized." Generally, as an institution is deemed to be less than well
capitalized, the scope and severity of the agencies' powers increase, ultimately
permitting the agency to appoint a receiver for the institution. Business
activities may also be influenced by an institution's capital classification. As
of December 31, 2003, Provident and The Provident Bank were deemed to be well
capitalized for the above purposes. See Note 15 included in "Notes to
Consolidated Financial Statements."
The monetary policies of regulatory authorities, including the Federal Reserve,
have a significant effect on the operating results of banks and bank holding
companies. The nature of future monetary policies and the effect of such
policies on the future business and income of Provident and its subsidiaries
cannot be predicted.
Red Capital Markets, Inc., a Provident Bank subsidiary, is licensed as a
securities broker-dealer and is subject to regulation by the Securities and
Exchange Commission, state securities authorities and the National Association
of Securities Dealers, Inc. Provident Insurance Agency, Inc., a subsidiary of
Red Capital Markets, is subject to regulation by state insurance authorities.
Provident Investment Advisors, Inc., a Provident subsidiary, is a registered
investment advisor, subject to regulation by the Securities and Exchange
Commission and state securities authorities.
3
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
ITEM 2. PROPERTIES
Provident and its significant subsidiaries occupy their headquarters located at
One East Fourth Street, Cincinnati, Ohio under long-term leases. Additional
operation centers are leased in Cincinnati, Columbus, Cleveland and Atlanta.
Provident owns buildings that contain approximately 422,000 square feet which
are used for offices, banking centers, data processing and warehouse facilities.
Provident owns thirty-four of its full-service banking center locations and
leases thirty-one. For information concerning rental obligations, see Note 7
included in "Notes to Consolidated Financial Statements."
ITEM 3. LEGAL PROCEEDINGS
Provident and its subsidiaries are not parties to any pending legal proceedings
other than routine litigation incidental to their business except for the
following matters related to the restatements announced March 5, 2003, and April
15, 2003. The restatement of previously reported operating results announced on
March 5, 2003, was attributed to unintentional errors in the accounting for nine
auto lease financing transactions originated between 1997 and 1999.
Provident's audit committee, through legal counsel, engaged the auditing firm of
PricewaterhouseCoopers LLP for the purpose of conducting a review of the
Company's March 5, 2003 restatement. Provident's management affirmed, based upon
the review of its advisors, its prior conclusion that the accounting errors that
led to the restatement were unintentional.
Several purported class-actions were filed against Provident, its President,
Robert L. Hoverson, its Chief Financial Officer, Christopher J. Carey, and their
predecessors in those positions, on behalf of all purchasers of Provident
securities from March 30, 1998 through March 5, 2003. Litigation was also filed
against Provident, its President, Robert L. Hoverson and its Chief Financial
Officer, Christopher J. Carey plus PFGI Capital Corporation, a Provident
subsidiary, and others on behalf of all purchasers of PRIDES in or traceable to
a June 6, 2002 offering of those securities registered with the Securities and
Exchange Commission and extending to March 5, 2003. That action alleges
violations of securities laws by the defendants in Provident's financial
disclosures during the period from March 30, 1998 through March 5, 2003 and in
the June 2002 offering. These actions are based upon circumstances involved in
the restatement of earnings announced by Provident on March 5, 2003 and allege
violations of federal securities laws by the defendants in Provident's financial
disclosures during the period from March 30, 1998 through March 5, 2003. They
seek an unspecified amount of damages and, in two cases, reimbursement of all
executive bonuses received during that period.
These actions were consolidated before Judge S. Arthur Spiegel of the United
States District Court for the Southern District of Ohio under the caption,
Merzin v. Provident Financial Group, Inc., consolidated Civil Action Master File
No. C-1-03-165. The Amended Consolidated Complaint was filed on August 22, 2003.
Provident and the other Defendants filed a Motion to Dismiss the Complaint on
November 5, 2003. The motion was granted on March 9, 2004 and the Court
dismissed all claims except those relating to the June 6, 2002 offering of
6,600,000 PRIDE securities. However, the Court's order confined any later
finding of damages to $0.70 per PRIDE security.
4
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
Several derivative actions have also been filed in federal and state courts on
behalf of Provident versus Provident's directors and others. These suits were
also concerned with the restatements of earnings and allege that the defendants
breached fiduciary duties owed to Provident and are responsible for the
conditions that led to the restatements and failed to ensure that the accounting
errors were prevented or detected. These actions seek recovery from the
defendants of an unspecified amount of damages and reimbursement of all
executive bonuses and stock options.
The derivative actions filed in federal court are pending before Chief Judge
Walter Herbert Rice of the United States District Court for the Southern
District of Ohio under the captions, Plumbers & Pipefitters Local 572 Pension
Fund v. Jack Cook, et al., Case No. C-1-03-168, and Peter Berg v. Jack M. Cook,
et al., Case No. C-1-03-196. Motions to dismiss the federal court derivative
actions were filed on behalf of all of the defendants on September 2, 2003.
Plaintiffs have opposed the motions. All proceedings in the derivative actions
filed in state court have been indefinitely stayed by agreement of the parties
and their respective legal counsel.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None in the fourth quarter.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
The Common Stock is traded on the NASDAQ Stock Market under the symbol "PFGI".
The following table sets forth, for the periods indicated, the high, low and
period end closing sales prices as reported on NASDAQ and the quarterly
dividends paid by Provident.
2003 2002
--------------------------------------------- ---------------------------------------------
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- ------- ------- -------
High Close $ 32.68 $ 28.78 $ 26.45 $ 28.91 $ 28.05 $ 29.51 $ 31.35 $ 29.97
Low Close 28.00 25.67 21.01 21.23 21.48 24.28 24.42 22.17
Period End Close 31.95 27.97 25.75 21.23 26.03 25.09 29.01 28.80
Cash Dividends .24 .24 .24 .24 .24 .24 .24 .24
At February 17, 2004, there were 4,946 holders of record and an additional
12,563 non-registered or "street name" holders of Provident's Common Stock.
Provident paid dividends on its Common Stock of $47.6 million and $47.4 million
during 2003 and 2002, respectively, and $0.9 million on its Preferred Stock for
both years. Provident's quarterly dividend rate per share was $.24 for 2003 and
2002. It is expected that in the next several years, Provident's (Parent's)
revenues will consist principally of dividends paid to it by its subsidiaries
and interest generated from investing activities. A discussion of limitations
and restrictions on the payment of dividends by subsidiaries to Provident is
contained under ITEM 7 "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity" and Note 25 included in "Notes
to Consolidated Financial Statements."
A report of purchases of equity securities is not required for this period.
5
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
ITEM 6. SELECTED FINANCIAL DATA
(Dollars In Millions For Year Ended December 31,
------------------------------------------------------------------------
Except Per Share Amounts) 2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
Earnings:
Total Interest Income $ 758 $ 841 $ 973 $ 906 $ 680
Total Interest Expense (442) (526) (703) (662) (430)
-------- -------- -------- -------- --------
Net Interest Income 316 315 270 244 250
Provision for Loan and Lease Losses (116) (99) (216) (133) (46)
Noninterest Income 845 805 757 660 537
Noninterest Expense (900) (876) (813) (680) (544)
-------- -------- -------- -------- --------
Income (Loss) Before Income Taxes and
Cumulative Effect of Changes in
Accounting Principles 145 145 (2) 91 197
Applicable Income Taxes (47) (50) 1 (34) (70)
-------- -------- -------- -------- --------
Income (Loss) Before Cumulative Effect
of Changes in Accounting Principles 98 95 (1) 57 127
Cumulative Effect of Changes in
Accounting Principles (1) -- -- -- --
-------- -------- -------- -------- --------
Net Income (Loss) $ 97 $ 95 $ (1) $ 57 $ 127
======== ======== ======== ======== ========
Per Common Share Data:
Before Cumulative Effect of Changes in
Accounting Principles:
Basic Earnings (Loss) $ 1.99 $ 1.94 $ (0.04) $ 1.14 $ 2.66
Diluted Earnings (Loss) 1.92 1.88 (0.04) 1.12 2.58
After Cumulative Effect of Changes in
Accounting Principles:
Basic Earnings (Loss) $ 1.96 $ 1.94 $ (0.04) $ 1.14 $ 2.66
Diluted Earnings (Loss) 1.90 1.88 (0.04) 1.12 2.58
Dividends Paid .96 .96 .96 .96 .88
Book Value 18.19 17.91 16.15 18.79 17.89
Selected Balances at December 31:
Total Investment Securities 4,528 4,215 3,486 3,014 2,111
Total Loans and Leases 8,896 9,134 8,950 7,996 6,634
Reserve for Loan and Lease Losses 160 201 241 159 95
Leased Equipment 1,653 2,350 2,651 2,386 1,807
Total Assets 17,018 17,540 16,561 14,997 11,849
Noninterest Bearing Deposits 1,491 1,142 995 1,293 1,185
Interest Bearing Deposits 8,844 8,707 7,859 7,536 6,045
Long-Term Debt and Junior
Subordinated Debentures 3,765 4,294 4,532 4,353 2,515
Total Shareholders' Equity 899 880 802 924 877
Off-Balance Sheet Managed Assets 1,344 2,068 3,138 4,621 4,641
Other Statistical Information:
Return on Average Assets 0.55% 0.58% -0.01% 0.42% 1.20%
Return on Average Equity 10.97 11.27 (0.11) 6.32 16.20
Dividend Payout Ratio 50.16 50.64 n/m 84.43 32.36
Capital Ratios at December 31:
Total Equity to Total Assets 5.28% 5.02% 4.84% 6.16% 7.40%
Tier 1 Leverage Ratio 8.13 7.81 6.65 8.21 9.67
Tier 1 Capital to Risk-Weighted Assets 10.59 9.40 7.95 8.56 8.57
Total Risk-Based Capital to
Risk-Weighted Assets 12.44 11.42 10.71 10.60 10.82
Loan Quality Ratios at December 31:
Reserve for Loan and Lease Losses to
Total Loans and Leases 1.80% 2.20% 2.69% 1.99% 1.43%
Reserve for Loan and Lease Losses to
Nonaccrual Loans 200.35 120.80 136.35 165.71 170.98
Nonaccrual Loans to Total Loans
and Leases 0.90 1.82 1.98 1.20 0.84
Net Charge-Offs to Average Total
Loans and Leases 1.73 1.59 1.63 1.04 0.51
- --------------------
n/m - not meaningful
6
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Introduction
Provident Financial Group, Inc. (Provident) is a holding company for The
Provident Bank (Provident Bank), an FDIC member bank. Major business lines are:
Commercial Banking, a provider of credit products and cash management services
to commercial customers; Retail Banking, a provider of consumer loans and
leases, deposit accounts, trust, brokerage and investment products and services;
and Mortgage Banking, an originator and servicer of conforming and nonconforming
residential loans to consumers and short-term financing to mortgage originators
and brokers.
During 2003 Provident took a number of strategic actions to lower the company's
risk profile and to align its core business with its corporate operating
strategy. The company reduced its risk profile through the sales of $471 million
of subprime residential loans in the second quarter, and approximately $112
million of other classified loans and aircraft leases in the fourth quarter.
Provident sold its merchant services business, a payment solutions provider for
credit and debit card acceptance programs, in the second quarter. During the
fourth quarter, 13 Florida branches along with various deposits and loans were
sold to RBC Centura Bank, a wholly-owned subsidiary of Royal Bank of Canada.
Sales of the merchant servicing business and the Florida branches will allow the
company to focus more on its core Midwest retail and commercial banking
franchise.
7
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Performance Summary
The following table summarizes three-year financial data for Provident, along
with calculated variances from the prior year:
Percentage
(Dollars in Millions Year Ended December 31, Increase (Decrease)
-------------------------------------- -----------------------
Except Per Share Data) 2003 2002 2001 2003/02 2002/01
-------- -------- -------- -------- --------
Net Interest Income $ 316 $ 315 $ 270 --% 17%
Noninterest Income 845 805 757 5 6
Total Revenue 1,161 1,120 1,027 4 9
Provision for Loan and Lease Losses 116 99 216 17 (54)
Noninterest Expense 900 876 813 3 8
Net Income (Loss) 97 95 (1) 2 --
Total Loans and Leases 8,896 9,134 8,950 (3) 2
Leased Equipment 1,653 2,350 2,651 (30) (11)
Total Assets 17,018 17,540 16,561 (3) 6
Total Off-Balance Sheet Managed Assets 1,344 2,068 3,138 (35) (34)
Total Deposits 10,336 9,849 8,854 5 11
Long-Term Debt and Junior
Subordinated Debentures 3,765 3,843 4,532 (2) (15)
Stockholders' Equity 899 880 802 2 10
Per Common Share:
Book Value 18.19 17.91 16.15 2 11
Diluted Earnings (Loss) 1.90 1.88 (0.04) -- --
Ratio Analysis:
Net Interest Margin 2.18% 2.41% 2.19%
Return on Average Equity 10.97% 11.27% -0.11%
Return on Average Assets 0.55% 0.58% -0.01%
Average Equity to
Average Assets 5.00% 5.12% 5.59%
Dividend Payout to
Net Earnings 50.16% 50.64% n/m
- --------------------
n/m - not meaningful
Provident reported net income (loss) of $96.7 million, $95.5 million and ($1.0)
million for 2003, 2002 and 2001, respectively. Diluted earnings (loss) per share
was $1.90 for 2003, compared to $1.88 for 2002 and ($0.04) for 2001. Return on
average equity was 10.97%, 11.27% and (0.11)% and return on average assets was
0.55%, 0.58% and (0.01)% for the years ended December 31, 2003, 2002 and 2001,
respectively.
All key credit ratios have improved significantly over year-end 2002. The
economy, while sluggish during 2002, showed signs of improvement in 2003, and
management anticipates a steady but slow improvement in 2004. Provident's
credit-related volatility has begun to stabilize. As a result of an improved
loan quality outlook, Provident lowered its loan loss reserve ratio from 2.20%
at December 31, 2002, to 1.80% at December 31, 2003. Due to sales of
nonperforming loans and leases in the second and fourth quarters of 2003,
Provident's reserve for loan and lease losses is now over 190% of nonperforming
assets.
Provident recorded provisions for loan and lease losses of $116.0 million, $99.5
million and $215.5 million in 2003, 2002 and 2001, respectively. The 2003
expense included $58.3 million related to the sales of subprime residential
loans, classified commercial loans, aircraft leases and the
8
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
impairment of aircraft lease residuals. Excluding these charges, Provident's
provision expense for 2003 would have been $57.7 million.
Revenue (net interest income plus noninterest income) increased 4% during 2003
over 2002 and 9% during 2002 over 2001. Net interest income was essentially
unchanged for 2003 compared to 2002, after increasing $45 million, or 17%, in
2002 compared to 2001. Higher net interest income in 2002 was primarily the
result of growth in the investment portfolio. Noninterest income increased $40
million in 2003 while increasing $48 million in 2002. The increase in
noninterest income in 2003 was due to the gain on sale of Florida assets and
liabilities in the fourth quarter, the sale of the Merchant Services business in
the second quarter and increases in commercial mortgage banking revenue,
partially offset by a decrease in leasing income. The decrease in leasing income
was a result of amortization of the portfolio and because auto leases originated
since February, 2003 have been classified as finance leases rather than
operating leases. In February, 2003, Provident changed the structure of the
residual insurance it obtains on its auto leases resulting in this type of
lending being classified as a direct financing lease in the loan category and
income being recorded as interest income. The increase in noninterest income
during 2002 was primarily the result of an increase in leasing income. Gain on
sales of loans and leases, a component of noninterest income, was $20.3 million,
$15.7 million and $6.3 million for 2003, 2002 and 2001, respectively. The
increases are primarily the result of gains recognized from whole-loan sales
(without recourse) of residential loans and the sale of home equity loans.
Total noninterest expense was $900 million, $876 million and $813 million for
2003, 2002 and 2001, respectively. Included in 2003 is a $25.6 million charge
related to the early retirement of debt and $6.9 million of expenses related to
the disposal of subprime residential mortgage loans. These costs, in addition to
increases in salary expense and professional fees, were partially offset by
decreases in leasing and other real estate expenses. Similar to leasing income,
leasing expense decreased due to auto leases originated since February 2003
being classified as finance leases rather than operating leases. The increase in
noninterest expense during 2002 was primarily the result of Provident investing
in businesses where strong growth opportunities exist, including middle-market
commercial lending, middle-market equipment leasing and mortgage servicing.
Also, significant investments were made within the credit and risk management
functions. Offsetting these increases were lower write-downs of foreclosed
properties and leased equipment.
Total assets at December 31, 2003, 2002 and 2001 were $17.0 billion, $17.5
billion and $16.6 billion, respectively. The decrease in 2003 was due primarily
to sales of classified commercial loans, aircraft leases, subprime residential
mortgage loans and Florida loans, partially offset by increases in home equity
lending and investment securities. Total assets increased during 2002 primarily
as a result of an increase in investment securities, middle-market equipment
lease financing and home equity loans. Partially offsetting these increases were
reductions in nonconforming residential loans, structured finance loans, large
equipment leases and auto leases. The changes in these loan and lease balances
reflect management's decision to lower the risk profile of its loan and lease
portfolio.
9
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Nonperforming assets at December 31, 2003 decreased approximately $98 million
from year-end 2002. The ratio of nonperforming assets to total assets was 0.49%,
1.04% and 1.19% as of December 31, 2003, 2002 and 2001, respectively. The
decrease in nonperforming assets is attributable to the sales of troubled loans
during the year and fewer loans being placed on nonaccrual. The improvements in
nonperforming asset levels and other asset quality indicators, as well as the
sale of nonperforming loans, resulted in the decision to lower the ratio of
reserve for loan and lease losses to total loans and leases to 1.80% as of
December 31, 2003 compared to 2.20% and 2.69% as of year-ends 2002 and 2001,
respectively.
Total deposits for 2003, 2002 and 2001 were $10.3 billion, $9.8 billion and $8.9
billion, respectively. Deposits increased during 2003 despite a reduction of
approximately $883 million as a result of the sale of Provident's Florida
branches that occurred during the fourth quarter of 2003. Commercial deposits
increased 68% to $1.1 billion during 2002. Beginning in 2003, Provident began
placing a renewed emphasis on increasing low-cost transactional deposits. This
included an increased emphasis on customer service and an aggressive marketing
campaign.
Shareholders' equity at December 31, 2003, 2002 and 2001 was $899 million, $880
million and $802 million, respectively. The increase in shareholders' equity
during 2003 was due principally to earnings exceeding dividends paid, partially
offset by a decrease in the mark-to-market on investment securities. In 2002
there was an increase in the mark-to-market of investment securities as well as
earnings exceeding dividends paid.
In conjunction with the sale of subprime residential mortgage loans and the
Merchant Services business during the second quarter of 2003 and the sale of
Florida assets and liabilities, sale of classified loans and leases, debt
retirement, and other non-recurring transactions during the fourth quarter of
2003, the company believes presenting financial information excluding these
transactions might be beneficial to the reader as it provides data that is more
comparable to other periods contained within this document. This does not infer
that (GAAP) earnings, as reported, which include the impact of such significant
transactions, are not meaningful or unimportant to management and investors. As
noted in the following table, excluding these transactions, Provident's net
income and diluted earnings per share for 2003 would have been $109.3 million
and $2.15 respectively. Additional discussion of each transaction follows the
table.
(Dollars in Millions, Excluding Selected Transactions, See Footnote:
--------------------------------------------------------------------------------------------
Except Per Share Data) (GAAP) (1) (2) (3) (4) (5) (6) (7) (Non-GAAP)
------- ------- ------- ------- ------- ------- ------- ------- -------
Year Ended
December 31, 2003:
Income Statement:
Net Interest Income $ 315.8 $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ 315.8
Provision (116.0) (33.2) -- -- (21.0) -- -- (4.1) (57.7)
Noninterest Income 845.3 -- 19.0 75.0 -- -- -- (2.8) 754.1
Noninterest Expense (900.1) (6.9) -- -- (6.5) (25.6) (10.8) -- (850.3)
------- ------- ------- ------- ------- ------- ------- ------- -------
Income Before Taxes 145.0 (40.1) 19.0 75.0 (27.5) (25.6) (10.8) (6.9) 161.9
Income Taxes (47.1) 13.2 (6.3) (26.2) 9.6 9.0 3.8 2.4 (52.6)
Effect of Changes
in Accounting
Principles (1.2) -- -- -- -- -- (1.2) -- --
------- ------- ------- ------- ------- ------- ------- ------- -------
Net Income $ 96.7 $ (26.9) $ 12.7 $ 48.8 $ (17.9) $ (16.6) $ (8.2) $ (4.5) $ 109.3
======= ======= ======= ======= ======= ======= ======= ======= =======
Other Data:
Diluted EPS $ 1.90 $ (0.53) $ 0.25 $ 0.96 $ (0.35) $ (0.33) $ (0.16) $ (0.09) $ 2.15
Return on Assets 0.55% (0.15%) 0.07% 0.28% (0.10%) (0.09%) (0.05%) (0.03%) 0.62%
Return on Equity 10.97% (3.05%) 1.44% 5.53% (2.02%) (1.89%) (0.93%) (0.51%) 12.40%
Net Charge Offs $ 157.0 $ 49.2 n/a $ 1.0 $ 44.1 n/a n/a $ 4.1 $ 58.6
Net Charge Offs to
Average Loans 1.73% n/a n/a n/a n/a n/a n/a n/a 0.65%
10
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(1) Sale of Subprime Residential Loans: During the second quarter of 2003,
Provident completed the sale of $471 million of subprime residential
mortgage loans and related assets. The loans were sold at a $40.1 million
net discount, of which $6.9 million was recorded as disposition cost in
noninterest expense.
(2) Sale of Merchant Services Business: Also during the second quarter,
Provident sold its Merchant Services business, a payment solutions
provider for credit and debit card acceptance programs. The sale of the
Merchant Services business resulted in a pre-tax gain of $19 million.
(3) Sale of Florida Deposits, Loans and Branches: Provident sold its 13
Florida branches, along with approximately $883 million of deposits and
$368 million in loans which were primarily originated at its Florida
offices, to RBC Centura Bank, a subsidiary of Royal Bank of Canada. The
transaction closed on November 21, 2003 and generated a pre-tax gain of
$75 million.
(4) Sale of Classified Loans and Aircraft Leases: During the fourth quarter of
2003, Provident sold approximately $50 million of classified loans and $62
million of aircraft leases. The loans and leases, which included
approximately $38 million of nonperforming assets, were sold at a pre-tax
loss of approximately $27.5 million.
(5) Retirement of Corporate Debt: Also in the fourth quarter, the company
recorded pre-tax charges of $25.6 million related to the prepayment of
$292.2 million of high-rate debt.
(6) Contract Termination, Severance, Business Exit Costs and Other: Provident
recorded pre-tax charges of $10.8 million on contract terminations,
severance and business exit costs. Additionally, Provident posted
cumulative effect of changes in accounting principles of $1.2 million (net
of tax). This was the result of new accounting rules implemented by FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities,"
which required Provident to consolidate certain securitization trusts.
(7) Impairment of Equity Investments and Aircraft Lease Residuals: Impairment
of equity investments and aircraft lease residuals resulted in a pre-tax
charge of $6.9 million. Residual values on commercial lease assets are
reviewed regularly for impairment. The deterioration in residual values of
aircraft was a result of continuing problems in the airline industry.
Business Initiatives
In recent years, Provident's profitability has been significantly impacted by
the downturn in the nation's economy and the resulting credit deterioration of
its lending portfolio. In order to compete effectively in today's economy and
grow shareholder value, Provident's goal is to become a lower risk company
engaged in achieving predictable and profitable long-term earnings growth.
Examples of how this goal is being achieved follows:
- - Discontinued or De-emphasized Higher Risk Lending Products: Provident is
11
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
reducing or exiting businesses with higher credit risk and where the
benefits received do not justify the risks taken. Provident has
de-emphasized both its Structured Finance business unit and its
Nonconforming Residential Lending Portfolio. Structured Finance provided
senior debt to support leveraged financings including management buyouts,
recapitalizations, acquisitions and business expansions. While Provident
continues to originate nonconforming residential loans, these loans are no
longer being held, but are sold with no retained recourse (credit risk).
These loans are being sold to third-parties whereby Provident recognizes a
gain on the sale.
Lending businesses where originations have been significantly reduced
include the Large Equipment Leasing and Auto Leasing business units. Large
Equipment Leasing is the financing of assets such as corporate and
commercial aircraft, construction, distribution, manufacturing and mining
equipment, as well as transportation equipment including trucks, tractors
and freight containers.
- - Sale of Higher Risk Portfolio Loans and Leases: Provident sold various
loans and leases during the past two years in order to accelerate the
reduction of higher risk loans and leases. Portfolio subprime mortgage
loans of $471 million and $27 million were sold during 2003 and 2002,
respectively. In addition, Provident sold $50 million of classified loans
and $62 million in aircraft leases during the fourth quarter of 2003.
These sales resulted in a less risky lending portfolio, improved credit
quality metrics and reduced future earnings volatility.
- - Expansion of Lower Risk Lending Products: Funding formerly used in the
higher risk areas noted above is being re-deployed toward lending products
which have lower credit risk and less volatile earnings. Provident is
expanding its Regional Commercial Banking, Middle-Market Equipment
Leasing, and Prime Home Equity business units. Each of these business
units are viewed by management as being areas of expertise for Provident
with lower risk profiles and better growth opportunities.
- - Monitoring of Risk: Over the past two years, Provident significantly
enhanced its monitoring of risk. The Credit and Risk Management Group is
responsible for establishing the framework for managing and overseeing
Provident's credit, operational and compliance risks. Accomplishments
within this area include improved and expanded credit policies,
implementation of an expanded risk rating system and updated credit risk
factors, as well as the addition of portfolio and information specialists,
retail analytics staff and centralized risk management operation units.
This has resulted in the timely resolution of credit issues, improved
credit quality and improved reporting, analysis and forecasting of the
credit quality of the lending portfolio.
- - Improvement of Capital and Liquidity Levels: During 2003, capital and
liquidity levels improved as a result of the sale of the Florida branch
network and Merchant Services business. The sale of the Florida branch
network included the sale of $883 million in deposits and $368 million in
loans. The sale of its Florida branch network also allows Provident to
further focus on its core Midwest retail and banking franchise.
12
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
- - Expansion of Fee Revenue Businesses: Provident is investing in businesses
that generate fee income. These businesses provide Provident with a steady
stream of income, with lower risk, while utilizing lower levels of
capital. Businesses which fit this description include Red Capital Group,
Capstone and Mortgage Banking. Each of these businesses provide a platform
to generate fee income from originating, selling and servicing of
commercial and residential mortgage loans.
- - Higher Concentration of Transaction Deposits: Stronger efforts are being
made to obtain low-cost transaction deposits. Included in these efforts is
the offering of a no fee deposit account product, improved service and
delivery processes, the use of a state-of-the-art contact management and
relationship building software tool in all branches, increased training
and enhanced incentive plans for branch associates, expanded focus on
commercial lending relationships to include their deposit business, and
improved internet banking capabilities.
- - Customer Focus: Beginning in 2004, Provident is placing a renewed emphasis
on the customer experience. A company-wide focus is being placed on
customer service, including the creation of "Raving Fans" whereby
customers will receive elevated customer service levels and improved
problem resolution processes. Additionally, Provident is implementing a
new brand image campaign which includes expanded advertising, a logo
change and branch additions.
Business Lines
Provident's major business lines are Commercial Banking, Retail Banking and
Mortgage Banking. The following table summarizes net income by major lines of
business for the years ended December 31, 2003 2002 and 2001. Condensed income
statements and total assets are provided in Note 21 of the "Notes to
Consolidated Financial Statements".
Percentage
Increase (Decrease)
-------------------
(Dollars in Millions) 2003 2002 2001 2003/02 2002/01
------- ------- ------- ------- -------
Net Income:
Commercial Banking $ 69.4 $ 57.7 $ (0.8) 20% n/m
Retail Banking 26.3 27.1 6.0 (3) 352%
Mortgage Banking 9.3 9.5 (6.2) (2) n/m
Corporate Center (8.3) 1.2 -- n/m n/m
------- ------- -------
$ 96.7 $ 95.5 $ (1.0) 1 n/m
======= ======= =======
- --------------------
n/m - not meaningful
Key components of the management reporting process follow:
- - Risk-Based Equity Allocations: Provident uses a comprehensive approach for
measuring risk and making risk-based equity allocations. Risk measurements
are applied to credit, operational and other corporate-level risks.
- - Transfer Pricing: Provident utilizes a matched funded transfer pricing
methodology that in most cases isolates the business units from
fluctuations in interest rates, and provides management with the ability
to measure business unit, product and customer level profitability based
on the financial characteristics of the products rather than the level of
interest rates.
13
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
- - Provision for Loan and Lease Losses: Business lines are charged for
provision based upon their level of net charge-offs as well as the size
and composition of their lending portfolio.
- - Cost Allocations: Provident applies a detailed approach to allocating
costs at the business unit, product and customer levels. Allocations are
generally based on volume/activity and are reviewed and updated regularly.
- - Corporate Center: Corporate Center includes balance sheet and income
statement items not allocated to the primary business lines, and gain/loss
on the sale of investment securities.
Business line descriptions and analyses follow:
- - Commercial Banking provides a broad range of commercial banking and
commercial real estate products, services and solutions. Areas of focus
and expertise include regional middle-market lending, equipment leasing
and financing, treasury management, and loan servicing, transaction
structuring and various capital solutions for the multi-family housing
industry. Primary operating groups within Commercial Banking are Regional
Middle-Market Commercial Banking, Commercial Real Estate, Middle-Market
Equipment Leasing and Financing and Corporate Services.
Net income for Commercial Banking for the years ending December 31, 2003,
2002 and 2001 was $69.4 million, $57.7 million and ($0.8) million,
respectively. Contributing to the higher net income for 2003 was an
increase in noninterest income and lower provision expense, which was
partially offset by lower net interest income and higher operating
expenses.
The growth in noninterest income came primarily from its fee-based
commercial real estate businesses, Red Capital Group and Capstone Realty
Advisors. Both Red Capital Group and Capstone recognized a significant
increase in revenue while utilizing lower levels of capital. The favorable
rate environment during the past year provided for an increased demand for
their services.
Average assets for 2003 increased $323 million, or 5%, compared to 2002.
However, net interest income for 2003 failed to keep pace with asset
growth due to modest spread compression. Furthermore, provision expense
decreased in 2003 primarily due to an overall improvement in credit
quality of the commercial loan portfolio.
Competitive product offerings contributed to an increase in deposits for
2003. Average commercial deposits for 2003 increased by $355 million, or
49%, as compared to 2002. Product offerings have attracted new
relationships and generated more business from the existing commercial
customer base.
The loss incurred during 2001 and the improvement in 2002 can be primarily
attributed to provision and other credit-related charges. During 2001,
Commercial Banking was affected by a weak economy which was accentuated by
the impact of the events of September 11, 2001. Commercial Banking
incurred credit write-offs and residual impairments from loans and leases
to the commercial airline industry. In addition, net income was reduced as
a result of higher loan loss provision due to a need to boost its reserve
for
14
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
loan and lease losses. Although the economy remained stagnant in 2002,
credit related volatility declined which resulted in Commercial Banking
benefiting from lower provision and other credit related charges during
2002 as compared to 2001.
Management continues to reposition this business line in order to produce
a more predictable earnings pattern. Management has de-emphasized its
higher credit risk areas of structured finance lending and large equipment
leasing while growing its lower credit risk areas of middle-market leasing
and regional middle-market commercial lending units.
- - Retail Banking provides a variety of deposit, credit and investment
products, services and solutions to consumers and small businesses through
various delivery channels including: branches, ATMs, a call center and the
internet. Consumer lending primarily focuses on offering home equity loans
to high credit-quality borrowers. Primary operating groups within Retail
Banking include Branch Banking, Business Banking and Consumer
Lending/Prime Home Equity. Retail Banking also includes Provident
Financial Advisors, which provides an extensive range of investment,
insurance and financial products, services and solutions to individuals,
businesses and government agencies.
Net income for Retail Banking was $26.3 million, $27.1 million and $6.0
million for the years ended December 31, 2003, 2002 and 2001,
respectively. The slight decrease in net income during 2003 occurred
primarily as a result of a decrease in net interest income on total retail
deposits. The decrease in the deposit net interest income is due primarily
to the current low interest rate environment. Management has directed its
efforts to the home equity lending business. This portfolio grew from $1.1
billion at December 31, 2002 to $1.5 billion at year-end 2003. Management
believes that the change in the overall lending portfolio mix will result
in an overall lower exposure to credit risk.
Transaction deposits for Retail Banking increased 18% in 2003. However,
total retail deposit growth decreased slightly due to less aggressive
pricing on certificates of deposits. Provident plans to further enhance
its distribution system to improve customer acquisition and market
penetration, including opening new branch locations.
Net income increased during 2002 primarily as a result of increased net
interest income on deposits and lower provision for loan and lease losses.
The lower provision was due to slower loan growth and a lower level of
loan loss reserves as compared to 2001.
- - Mortgage Banking offers conforming and nonconforming residential mortgage
loans to consumers, and also provides fee-based loan processing, loan
warehousing and servicing for third party originators. Loans are
originated through retail, broker and correspondent channels and are sold
on a non-recourse whole-loan basis. Primary operating areas within
Mortgage Banking include Residential Mortgage Origination and Sales,
Third-Party Loan Servicing and Warehouse Lending Services.
Net income for 2003 was $9.3 million as compared to net income of $9.5
million for 2002 and net loss of $6.2 million for 2001. Positive trends
within Mortgage Banking included the contributions of Warehouse Lending
15
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
which funded loans of $12.7 billion in 2003 versus $7.8 billion in 2002.
The servicing balance for third-party originators (excludes securitized
loans) also continued to rise in 2003, increasing from $5.1 billion on
December 31, 2002 to $10.1 billion on December 31, 2003. Gains recognized
on the sale of loans was $11.9 million during 2003 compared to $13.8
million for 2002.
The net loss reported in 2001 was driven by the decision to change the
structure of securitizations resulting in the elimination of gain-on-sale
accounting. This decision resulted in no gain on sales of securitized
loans being recognized in 2001 as compared to pre-tax gains of $30.3
million being recognized during 2000.
Mortgage Banking, following the overall company strategy of risk
reduction, continues to implement strategic initiatives to reduce the
business' risk profile. Nonconforming loan originations continue to be
sold to investors on a whole-loan basis.
- - Corporate Center includes revenues and expenses not allocated to the
primary business lines, including any item not related to their operating
activity. The net loss of $8.3 million for 2003 and net income of $1.2
million for 2002 resulted from the following actions taken by management:
the sale of subprime loans, Merchant Services, Florida assets and
liabilities, and classified loans and aircraft leases; the early
retirement of higher interest rate debt; contract termination, severance
and business exit costs; and the impairment of equity investments and
aircraft lease residuals. Corporate Center also includes realized gains on
security sales and certain warrant gains.
Related Party Transactions
Provident, in its normal course of business, has had transactions with its
directors, officers, principal shareholders and affiliates including American
Financial Group, Inc. and its subsidiaries. All such transactions are on terms
no less favorable to Provident than those which could be obtained with
non-affiliated parties. These transactions include the leasing of its corporate
headquarters and additional office space, insurance coverage, advertising,
tickets, suite rental, record retention services, guard services, extensions of
credit, and maintaining investments of commercial paper, repurchase agreements
and deposit accounts. For details concerning these transactions, see Note 22 of
the "Notes to Consolidated Financial Statements."
Net Interest Income
Net interest income for the year ended December 31, 2003, was essentially
unchanged compared to 2002. Interest income and interest expense declined
approximately $84 million each. Increases in the average balances of interest
earning assets and interest bearing liabilities were offset by lower average
interest rates.
16
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Net interest margin represents net interest income as a percentage of average
interest earning assets. The net interest margin, on a tax-equivalent basis, was
2.18%, 2.41% and 2.19% for 2003, 2002 and 2001, respectively. Average loan
balances include nonperforming loans. This decrease was driven by changes in
rates and volumes of earning assets and the corresponding funding sources. The
net interest spread is the difference between the average yield earned on assets
and the average rate incurred on liabilities. The following table details the
components of the change in net interest income and expense (on a tax-equivalent
basis) by major category of interest earning assets and interest bearing
liabilities for the years ended December 31, 2003, 2002 and 2001.
Year Ended December 31,
-----------------------------------------------------------------------------------------
2003 2002 2001
---------------------------- ---------------------------- ----------------------------
Average Income/ Avg. Average Income/ Avg. Average Income/ Avg.
(Dollars in Millions) Balance Expense Rate Balance Expense Rate Balance Expense Rate
------- ------- ------- ------- ------- ------- ------- ------- -------
ASSETS
Interest Earning Assets:
Loans/Leases:
Corporate Lending:
Commercial $ 4,388 $ 247.0 5.63% $ 4,312 $ 273.4 6.34% $ 4,655 $ 377.2 8.10%
Mortgage 949 52.0 5.48 909 56.5 6.22 864 69.2 8.02
Construction 515 21.6 4.20 546 24.6 4.51 570 40.5 7.10
Lease Financing 1,254 104.7 8.35 1,199 109.9 9.16 958 92.4 9.65
Consumer Lending:
Installment 1,487 67.7 4.55 1,054 65.4 6.21 774 68.7 8.87
Residential 266 29.6 11.12 737 70.6 9.59 1,008 99.9 9.91
Lease Financing 192 12.6 6.56 -- -- -- -- -- --
------- ------- ------- ------- ------- ------- ------- ------- -------
Total Loans/Leases 9,051 535.2 5.91 8,757 600.4 6.86 8,829 747.9 8.47
Investment Securities 4,514 186.5 4.13 3,882 217.7 5.61 3,158 204.5 6.47
Federal Funds Sold and
Reverse Repurchase
Agreements 395 7.0 1.76 125 3.4 2.71 92 4.2 4.59
Other Short-Term
Investments 542 29.0 5.35 341 20.0 5.85 297 16.8 5.66
------- ------- ------- ------- ------- ------- ------- ------- -------
Total Earning Assets 14,502 757.7 5.22% 13,105 841.5 6.42% 12,376 973.4 7.86%
Cash and Noninterest
Bearing Deposits 301 255 255
Leased Equipment 1,999 2,477 2,491
Other Assets 817 701 926
------- ------- -------
Total Assets $17,619 $16,538 $16,048
======= ======= =======
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest Bearing
Liabilities:
Deposits:
Demand Deposits $ 1,161 15.9 1.37% $ 696 9.8 1.40% $ 484 12.1 2.50%
Savings Deposits 1,517 26.2 1.73 1,472 29.0 1.97 1,548 56.5 3.65
Time Deposits 6,643 173.5 2.61 6,134 223.4 3.64 5,828 317.8 5.45
------- ------- ------- ------- ------- ------- ------- ------- -------
Total Deposits 9,321 215.6 2.31 8,302 262.2 3.16 7,860 386.4 4.92
Short-Term Debt:
Federal Funds
Purchased and
Repurchase Agreements 1,206 28.0 2.32 1,182 30.3 2.56 1,156 46.8 4.05
Commercial Paper 265 3.2 1.23 280 5.3 1.91 229 9.0 3.92
------- ------- ------- ------- ------- ------- ------- ------- -------
Total Short-Term Debt 1,471 31.2 2.12 1,462 35.6 2.44 1,385 55.8 4.03
Long-Term Debt 3,609 176.6 4.89 3,990 204.7 5.13 3,877 230.1 5.93
Junior Subordinated
Debentures 451 18.3 4.04 451 23.3 5.16 422 30.5 7.24
------- ------- ------- ------- ------- ------- ------- ------- -------
Total Interest Bearing
Liabilities 14,852 441.7 2.97% 14,205 525.8 3.70% 13,544 702.8 5.19%
Noninterest Bearing
Deposits 1,327 945 1,220
Other Liabilities 558 541 387
Shareholders' Equity 882 847 897
------- ------- ------- ------- ------- ------- ------- ------- -------
Total Liabilities and
Shareholders' Equity $17,619 $16,538 $16,048
======= ======= =======
Net Interest Income $ 316.0 $ 315.7 $ 270.6
======= ======= =======
Net Interest Margin 2.18% 2.41% 2.19%
======= ======= =======
Net Interest Spread 2.25% 2.72% 2.67%
======= ======= =======
17
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following table shows the changes in net interest income on a tax equivalent
basis resulting from changes in volume and changes in rates. Changes not solely
due to volume or rate have been allocated proportionately.
Year Ended December 31,
---------------------------------------------------------
2003 Changes from 2002 Changes from
2002 Due to 2001 Due to
------------------------- -------------------------
(In Thousands) Volume Rate Volume Rate
--------- --------- --------- ---------
Interest Earned On:
Loans and Leases:
Corporate Lending:
Commercial $ 4,747 $ (31,195) $ (26,271) $ (77,508)
Mortgage 2,416 (6,941) 3,449 (16,189)
Construction (1,338) (1,674) (1,681) (14,192)
Lease Financing 4,899 (10,058) 22,311 (4,845)
Consumer Lending:
Installment 22,522 (20,272) 20,724 (23,977)
Residential (50,915) 9,876 (26,138) (3,179)
Lease Financing 12,632 -- -- --
--------- --------- --------- ---------
Net Loans and Leases (5,037) (60,264) (7,606) (139,890)
Investment Securities 31,866 (63,074) 42,933 (29,647)
Federal Funds Sold and
Reverse Repurchase Agreements 5,112 (1,544) 1,217 (2,068)
Short-Term Investments 10,901 (1,829) 2,529 594
--------- --------- --------- ---------
Total 42,842 (126,711) 39,073 (171,011)
--------- --------- --------- ---------
Interest Paid On:
Demand Deposits 6,375 (229) 4,136 (6,441)
Savings Deposits 855 (3,608) (2,643) (24,864)
Time Deposits 17,328 (67,251) 15,968 (110,354)
--------- --------- --------- ---------
Total Deposits 24,558 (71,088) 17,461 (141,659)
Short-Term Debt:
Federal Funds Purchased
and Repurchase Agreements 622 (2,942) 1,016 (17,567)
Commercial Paper (278) (1,813) 1,695 (5,321)
--------- --------- --------- ---------
Total Short-Term Debt 344 (4,755) 2,711 (22,888)
Long-Term Debt (18,928) (9,172) 6,560 (31,879)
Junior Subordinated Debentures 23 (5,045) 1,974 (9,251)
--------- --------- --------- ---------
Total 5,997 (90,060) 28,706 (205,677)
--------- --------- --------- ---------
Net Interest Income $ 36,845 $ (36,651) $ 10,367 $ 34,666
========= ========= ========= =========
Noninterest Income
The following table details the components of noninterest income and their
change since 2001:
Percentage
Increase (Decrease)
------------------------
(Dollars in Thousands) 2003 2002 2001 2003/02 2002/01
-------- -------- -------- -------- --------
Service Charges on Deposit Accounts $ 50,023 $ 45,184 $ 39,924 11% 13%
Loan Servicing Fees 40,163 36,980 34,469 9 7
Commercial Mortgage Banking Revenue 44,791 25,354 29,490 77 (14)
Other Service Charges and Fees 50,935 45,418 37,390 12 22
Leasing Income 510,109 605,887 584,065 (16) 4
Cash Gain on Sales of Loans 20,333 15,691 6,311 30 149
Warrant Gains 1,636 8,186 412 (80) 1,887
Security Gains 6,307 2,596 -- 143 --
Net Gain on Florida Assets and Liabilities 74,998 -- -- -- --
Net Gain on Merchant Services Business 19,000 -- -- -- --
Other 26,994 20,196 24,375 34 (17)
-------- -------- --------
Total Noninterest Income $845,289 $805,492 $756,436 5% 7%
======== ======== ========
18
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Explanations for significant changes in noninterest income by category follow:
- - Service Charges on Deposit Accounts: Increases in overdraft fees and
service charges on corporate deposit accounts were the primary reasons for
the increase in service charges on deposit accounts in both 2003 and 2002.
- - Loan Servicing Fees: In 2003, mortgage servicing fees increased for both
residential and multi-family loans. Loan servicing fees increased during
2002 as increases in fees from servicing multi-family loans and
residential mortgage loans were partially offset by decreases in fees from
servicing securitized residential mortgage and credit card portfolios.
Total loans serviced for others at December 31, 2003, 2002 and 2001 were
$21.1 billion, $17.5 billion and $12.5 billion.
- - Commercial Mortgage Banking Fees: Increases in fees from both Red Capital
Group and Capstone resulted in higher commercial mortgage banking fees in
2003. A decrease in commercial mortgage banking fees from Red Capital
Group was the primary reason for the decrease in 2002.
- - Other Service Charges and Fees: During 2003, other service charges and
fees increased due primarily to increased fees from commercial banking and
trust services. These increases offset a decline in fees due to the sale
of Provident's merchant services business in the second quarter of 2003.
Other service charges and fees increased during 2002 due primarily to an
increase in other fee income generated from Mortgage Banking and funds
management fees, more than offsetting a decrease in credit card fees.
- - Leasing Income: The decrease in leasing income in 2003 was a result of
amortization of the portfolio and because auto leases originated since
February, 2003 have been classified as finance leases rather than
operating leases. In February, 2003, Provident changed the structure of
the residual insurance it obtains on its auto leases resulting in this
type of lending being classified as a direct financing lease in the loan
category and income being recorded as interest income. Leasing income
increased during 2002 due primarily to increases in income from auto
leases.
- - Gain on Sales of Loans and Leases: Gain on sales of loans and leases
increased $4.6 million in 2003, due primarily to strong growth in the
sales of home equity loans and lines of credit tempered by slower than
expected production levels in mortgage whole-loan sales. The $9.4 million
increase in 2002 was a result of gains recognized from the sale of
nonconforming residential mortgage loans on a whole-loan basis, a strategy
that Provident implemented during the third quarter of 2001. The following
table provides detail of the gain on sales recognized during the past
three years.
(In Thousands) 2003 2002 2001
------- ------- -------
Cash Gains -- Loan and Lease Sales:
Nonconforming Residential Whole-Loan Sales $11,912 $13,756 $ 3,177
Home Equity Loan Sales 7,293 1,253 --
Conforming Residential Whole-Loan Sales 792 306 1,544
Other Loan Sales 336 376 1,590
------- ------- -------
$20,333 $15,691 $ 6,311
======= ======= =======
19
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
- - Warrant Gains: Provident's Commercial Banking business line from time to
time acquires equity warrants as a part of the lending fee structure
established with customers. Warrant gains totaled $1.6 million for 2003 as
compared to $8.2 million for 2002 and $0.4 million for 2001.
- - As part of its strategic repositioning, Provident sold the Merchant
Services business in the second quarter and Florida branches, deposits and
loans in the fourth quarter of 2003. These sales resulted in gains of $19
million and $75 million, respectively.
- - Other: An increase in fees associated with investment portfolio management
and other trading activities was the primary reason for the increase in
other income in 2003. The decrease in other income during 2002 was due
primarily to a decrease in income from equity investments.
Noninterest Expense
The following table details the components of noninterest expense and their
change since 2001:
Percentage
Increase (Decrease)
------------------------
(Dollars in Thousands) 2003 2002 2001 2003/02 2002/01
-------- -------- -------- -------- --------
Salaries, Wages and Benefits $253,399 $233,178 $201,715 9% 16%
Charges and Fees 32,152 30,531 31,888 5 (4)
Occupancy 25,365 23,637 22,605 7 5
Leasing Expense 365,408 416,508 402,372 (12) 4
Equipment Expense 26,285 24,345 25,234 8 (4)
Professional Fees 32,667 25,990 24,507 26 6
Minority Interest Expense 12,788 7,069 -- 81 --
Debt Retirement Charge 25,584 -- -- -- --
Disposition Cost of Subprime Loans 6,914 -- -- -- --
Other 119,493 114,770 104,663 4 10
-------- -------- --------
Total Noninterest Expense $900,055 $876,028 $812,984 3% 8%
======== ======== ========
Components of noninterest expense, along with an explanation as to their
fluctuations, follow:
- - Salaries, Wages and Benefits: Salaries, wages and benefits increased $20.2
million in 2003 due primarily to increased commissions for commercial
mortgage banking activities and staffing increases in loan servicing, risk
management and retail. Compensation increased in 2002 due primarily to
increased staffing and incentive pay in areas where opportunities for
growth exist, such as middle-market commercial lending, middle-market
equipment leasing and mortgage servicing.
- - Charges and Fees: Charges and fees increased in 2003 due to a $3.5 million
writedown of intangible assets, partially offset by a decrease in expenses
related to credit risk transfer transactions. The decrease in 2002
resulted from the decrease in goodwill amortization expense more than
offsetting the increase in expenses related to credit risk transfer
transactions. Details concerning goodwill amortization and credit transfer
transactions are provided in Notes 8 and 20, respectively, included in
"Notes to Consolidated Financial Statements."
20
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
- - Occupancy: Increased rent expense along with depreciation expense for
leased branches were the primary reasons for higher occupancy expense in
2003. The increase in 2002 over 2001 was due to higher depreciation
expense, guard services and utilities.
- - Leasing Expense: Similar to leasing income, leasing expense decreased in
2003 due to auto leases originated since February 2003 being classified as
finance leases rather than operating leases. An increase in auto lease
depreciation expense was the primary reason for the increase in leasing
expense for both 2002 and 2001.
- - Equipment Expense: Equipment expense increased in 2003 primarily due to
increased depreciation expense and equipment rental expense, while the
decrease in 2002 was due primarily to a reduction in depreciation expense.
- - Professional Fees: Professional fees increased in 2003 primarily as a
result of increased legal fees for the Commercial Banking area and
corporate litigation. Professional fees increased in 2002 due primarily to
legal, consulting and other professional fees related to loan collections.
- - Minority Interest Expense: Minority interest expense relates to dividends
payable on $165 million of Preferred Stock of PFGI Capital Corporation, a
real estate investment trust that was formed late in the second quarter of
2002. The expense for 2003 contains a full year of dividend payments. The
dividends are payable at an annualized rate of 7.75%. Additional
information on minority interest may be found on Note 13 of "Notes to
Consolidated Financial Statements."
- - Debt Retirement Charge: In the fourth quarter of 2003, Provident recorded
charges related to the early retirement of high-rate debt. The total debt
retired amounted to $292.2 million.
- - Disposition Cost of Subprime Loans: Provident sold subprime residential
mortgage loans and foreclosed properties during the second quarter of
2003. Disposition costs of $6.9 million were recorded from the loss on
sale of other real estate and other contingencies associated with the
sale.
- - Other: Larger expenses included within other noninterest expense include
marketing ($10.8 million, $11.0 million and $9.2 million in 2003, 2002,
and 2001, respectively), travel ($10.4 million, $8.9 million and $9.0
million in 2003, 2002 and 2001, respectively), franchise taxes ($8.5
million, $7.0 million and $8.5 million in 2003, 2002 and 2001,
respectively), data processing expense ($10.0 million, $7.8 million and
$5.6 million in 2003, 2002 and 2001, respectively) and insurance expense
($14.8 million, $13.1 million and $10.4 million in 2003, 2002 and 2001,
respectively).
21
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
Short-Term Investments and Investment Securities
As of December 31, 2003 and 2002, federal funds sold and reverse repurchase
agreements outstanding were $253.3 million and $188.9 million, respectively. The
amount of federal funds sold changes daily as cash is managed to meet reserve
requirements and customer needs. After funds have been allocated to meet lending
and investment demands, any remainder is placed in overnight federal funds.
As of December 31, 2003 and 2002, Provident held $119.6 million and $127.8,
respectively, in trading account securities. Provident trades investment
securities with the intention of recognizing short-term profits. These
securities are carried at fair value with realized and unrealized gains and
losses reported in other noninterest income.
Provident classified $595.5 million and $436.9 million of loans as held for sale
at December 31, 2003 and 2002, respectively. At year-end 2003, these loans
consisted of $479.9 million of multifamily loans, $106.1 million of
nonconforming residential mortgage loans, $6.4 million of conforming residential
mortgage loans and $3.1 million of commercial leases. Activities related to the
multifamily loans held for sale are predominantly a part of the operations of
Red Capital Group. The multifamily loans are either insured by the Federal
Housing Association or subject to purchase contracts from Fannie Mae or Freddie
Mac. These loans are usually outstanding for sixty days or less. The remainder
of the activities related to the multifamily loans held for sale are part of the
operations of Capstone Realty Advisors. Nonconforming residential mortgage loans
are being sold on a whole-loan basis. This is part of an initiative started
during 2001 to reduce the risk profile of the Mortgage Banking business line.
Investment securities purchased with the intention of being held for indefinite
periods of time are classified as available for sale. These securities totaled
$4.5 billion and $4.2 billion as of December 31, 2003 and 2002, respectively.
During 2003, Provident actively changed its investment portfolio mix from
mortgage-backed pass-through securities to agency debt and collateralized
mortgage obligations. As a result, Provident was able to shorten the overall
duration of its investment portfolio, thereby reducing its interest rate risk
exposure to rising interest rates and also reducing the market value
fluctuations on the overall portfolio.
22
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The amortized cost and market value of investment securities available for sale
at the dates indicated are summarized in the following table:
Amortized Cost at December 31,
----------------------------------------
(In Thousands) 2003 2002 2001
- ----------------------------------------- ---------- ---------- ----------
US Treasury and Federal Agency Debentures $ 608,808 $ 310,244 $ 302,912
State and Political Subdivisions 1,360 1,838 3,185
Mortgage-Backed Securities 3,250,117 3,240,192 2,700,620
Other Securities 714,192 606,237 503,884
---------- ---------- ----------
Total Securities $4,574,477 $4,158,511 $3,510,601
========== ========== ==========
Market Value at December 31,
----------------------------------------
(In Thousands) 2003 2002 2001
- ----------------------------------------- ---------- ---------- ----------
US Treasury and Federal Agency Debentures $ 611,122 $ 316,143 $ 306,556
State and Political Subdivisions 1,400 1,875 3,199
Mortgage-Backed Securities 3,207,230 3,291,512 2,673,174
Other Securities 708,160 605,708 503,129
---------- ---------- ----------
Total Securities $4,527,912 $4,215,238 $3,486,058
========== ========== ==========
The following table shows the December 31, 2003 maturities and weighted average
yields for investment securities. Yields on equity securities that comprise the
fixed rate, due after 10 years classification of other securities have been
omitted from the table. A 35% tax rate was used in computing the tax equivalent
yield adjustment. The yields shown are calculated based on amortized cost and
effective yields weighted for the scheduled maturity of each security.
Securities are assigned to maturity categories based on their estimated average
lives.
Fixed Rate Floating Rate
------------------------------ ------------------------------
Weighted
Weighted Average
Average Yield On
Amortized Yield To Amortized Current
(Dollars in Thousands) Cost Maturity Cost Coupon Rates
- ---------------------- ---- -------- ---- ------------
US Treasury and Federal Agency
Debentures:
Due in one year or less $ 312,352 4.22% $ 749 1.06%
Due after 1 through 5 years 174,819 3.41 --
Due after 10 years -- 120,888 4.19
---------- ------- ---------- -------
Total $ 487,171 3.93% $ 121,637 4.17%
========== ======= ========== =======
State and Political Subdivisions:
Due after 10 years $ 1,360 7.66% $ -- --%
========== ======= ========== =======
Mortgage-Backed Securities:
Due in one year or less $ 95,243 5.29% $ -- --%
Due after 1 through 5 years 2,434,157 5.46 2,625 2.64
Due after 5 through 10 years 519,850 4.68 11,798 2.85
Due after 10 years 165,437 6.58 21,007 2.67
---------- ------- ---------- -------
Total $3,214,687 5.39% $ 35,430 2.73%
========== ======= ========== =======
Other Securities:
Due in one year or less $ -- --% $ 31,698 1.37%
Due after 1 through 5 years 172,768 6.49 329,915 1.53
Due after 5 through 10 years -- -- 21,383 2.32
Due after 10 years 118,428 -- 40,000 2.35
---------- ------- ---------- -------
Total $ 291,196 6.49% $ 422,996 1.64%
========== ======= ========== =======
23
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Loans and Leases
As of December 31, 2003 and 2002, total on-balance sheet loans and leases were
$8.9 billion and $9.1 billion, respectively. Provident had an additional $1.3
billion and $2.1 billion of off-balance sheet securitized loans and leases and
$3.8 billion and $3.0 billion of Fannie Mae DUS loans as of year-end 2003 and
2002, respectively. As a result of recent earnings volatility, management
re-evaluated the risk/reward relationships of its lending portfolio. During the
second half of 2001, Provident implemented a whole-loan sale strategy for its
nonconforming residential loans. During the second quarter of 2003, Provident
sold nearly all of the subprime residential mortgage loan portfolio. Also,
management decided to de-emphasize structured finance lending and large-ticket
equipment leasing while placing a greater focus on regional middle-market
commercial lending and middle-market equipment leasing. During the fourth
quarter of 2003, Provident sold approximately $112 million of commercial loans
and leases, many of which involved financing to the commercial airline industry.
As a result of these actions, Provident's lending portfolio has a much lower
concentration of subprime residential loans and commercial airline industry
loans, a higher concentration of middle-market corporate leases, and a lower
risk profile of commercial loans. Provident does not have material exposure to
foreign loans. The following table shows on-balance sheet loans and leases
outstanding at period end by type of loan:
December 31,
---------------------------------------------------------------------
(Dollars in Millions) 2003 2002 2001 2000 1999
- ------------------------- --------- --------- --------- --------- ---------
Dollar:
Corporate Lending:
Commercial $ 4,038.5 $ 4,482.4 $4,540.1 $4,580.2 $3,990.9
Mortgage 961.9 960.6 939.8 823.5 576.6
Construction 452.6 510.3 528.0 610.5 559.8
Lease Financing 1,275.3 1,273.9 1,106.1 566.1 376.6
Consumer Lending:
Installment 1,670.7 1,306.8 913.4 580.1 476.5
Residential 36.2 599.8 922.7 835.5 653.7
Lease Financing 460.3 -- -- -- --
--------- --------- -------- -------- --------
Total Loans and Leases $ 8,895.5 $ 9,133.8 $8,950.1 $7,995.9 $6,634.1
========= ========= ======== ======== ========
Percentage:
Corporate Lending:
Commercial 45.4% 49.1% 5.07% 57.3% 60.1%
Mortgage 10.8 10.5 10.5 10.3 8.7
Construction 5.1 5.6 5.9 7.6 8.4
Lease Financing 14.3 13.9 12.4 7.1 5.7
Consumer Lending:
Installment 18.8 14.3 10.2 7.3 7.2
Residential 0.4 6.6 10.3 10.4 9.9
Lease Financing 5.2 -- -- -- --
--------- --------- --------- -------- -------
Total Loans and Leases 100.0% 100.0% 100.0% 100.0% 100.0%
========= ========= ========= ======== =======
24
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following table shows the composition of the commercial loan category by
industry type at December 31, 2003, including loan amounts on which interest is
not being accrued:
Amount on
(Dollars in Millions) Amount % Nonaccrual
- ---------------------------------------------------- ------------- ---- ----------
Real Estate Operators/Developers/General Contractors $ 494.3 12 $ 8.8
Mortgage Warehousing Lines 493.5 12 4.6
Banking and Finance Activities 194.8 5 11.1
Transportation 186.7 5 0.3
Healthcare 175.7 4 0.6
Business Services 157.7 4 8.6
Metals 152.9 4 1.8
Retailing 141.7 3 0.1
Tourism and Entertainment 139.2 3 0.1
Automobile Dealers 121.5 3 --
Machinery and Equipment 114.4 3 4.5
Construction 106.6 3 0.9
Commercial Aviation Related (1) 103.5 3 13.3
Eating and Drinking Establishments 96.6 2 0.2
Financial Services 89.3 2 1.7
Automotive Services/Parts 76.7 2 2.8
Chemicals 65.4 2 --
Technology 63.7 2 3.3
Other (includes 20 industry types) 1,064.3 26 7.6
----------- --- --------
Total $ 4,038.5 100 $ 62.3
=========== === ========
(1) Includes $20 million of loans related to the commercial airline industry,
and aircraft used in private, charter and corporate markets
Consistent with lower activity within the industry, mortgage warehousing lines
decreased $146 million during 2003 to $494 million. All loans are underwritten
to Provident and secondary market standards as part of Provident's control
processes related to this activity.
At December 31, 2003, Provident had loans and leases of $97 million to
commercial airline carriers, including $20 million of commercial loans and $77
million of finance and operating leases. The $81 million decrease during 2003
was primarily as a result of the commercial loan and lease sales that occurred
in the fourth quarter of 2003. As the events of September 11, 2001 continued to
have a significant financial impact upon the airline industry and the resale
value of aircraft, Provident recorded credit costs and other expenses of $36
million and $34 million during 2003 and 2002, respectively, related to secured
commercial airline loans and leases.
At December 31, 2003, Provident had approximately $626 million of commercial
loans that are to borrowers who have shared national credit loans. Generally,
shared national credit loans are loans that have a commitment amount of at least
$20 million and involve three or more supervised financial institutions. In an
on-going effort to diversify its portfolio, the shared national credit loans in
which Provident participates are distributed across thirty-two industry types,
with the largest industry concentration (real estate) accounting for
approximately 14% of its total shared national credit loans. The real estate
category is comprised of loans to borrowers with different risks
characteristics, including single family home developers, commercial property
owner/operators, and commercial realtors and property managers. The average
outstanding balance of a shared national credit loan was $3.9 million.
25
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following table shows the composition of commercial mortgage and
construction loans by property type at December 31, 2003:
Commercial Commercial Amount on
(Dollars in Millions) Mortgage Construction Total Percentage Nonaccrual
- --------------------- -------- ------------ ----- ---------- ----------
Office / Warehouse $ 179.6 $ 70.2 $ 249.8 17.7% $ 5.6
Residential Development 126.7 108.5 235.2 16.6 3.3
Apartments 166.5 57.1 223.6 15.8 1.2
Shopping / Retail 124.5 43.4 167.9 11.9 --
Healthcare Facilities 98.1 6.5 104.6 7.4 --
Hotel / Motel 83.1 2.8 85.9 6.1 .1
Land 30.9 41.1 72.0 5.1 --
Industrial Plants 27.7 -- 27.7 1.9 --
Other Commercial Properties 124.8 123.0 247.8 17.5 .4
-------- -------- -------- -------- --------
$ 961.9 $ 452.6 $1,414.5 100.0% $ 10.6
======== ======== ======== ======== ========
Commercial and real estate construction loans outstanding at December 31, 2003
are shown in the following table by maturity, based on remaining scheduled
repayments of principal:
After 1
Within but Through After
(In Millions) 1 Year 5 Years 5 Years Total
- ------------- ------ ------- ------- -----
Commercial $1,713.9 $2,006.9 $ 317.7 $4,038.5
Commercial Construction 247.2 178.6 26.8 452.6
-------- -------- -------- --------
Total $1,961.1 $2,185.5 $ 344.5 $4,491.1
======== ======== ======== ========
Loans Due After One Year:
At predetermined interest rates $ 229.9
At floating interest rates 2,300.2
As of December 31, 2003, Provident had $1.3 billion in commercial lease
financings. These leases were comprised of $1.1 billion of mid-ticket equipment
leases and $0.2 billion of large-ticket equipment leases.
Residential mortgage loans decreased $564 million during 2003, due to the sale
of subprime residential mortgage loans that occurred in the second quarter of
2003. Prior to the loan sale, residential mortgage loans had been declining due
to Provident's implementing a whole-loan sale strategy for its nonconforming
residential loans during the second half of 2001. The loan sale, which also
lowered the level of nonperforming assets, gives Provident a lower concentration
of nonconforming residential loans and allows it to concentrate more of its
resources on its strategic initiatives such as home equity, regional lending and
mid-ticket leasing portfolios.
The following table shows the composition of the installment loan category by
loan type at December 31:
Percentage
Increase
(Dollars in Millions) 2003 2002 (Decrease)
- --------------------- ---- ---- ----------
Home Equity $1,484.4 $1,110.7 33.6%
Indirect Installment 123.2 120.3 2.4
Direct Installment 46.1 60.1 (23.3)
Other Consumer Loans 17.0 15.7 8.3
-------- -------- --------
$1,670.7 $1,306.8 21.0%
======== ======== ========
26
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Credit Risk Management
Over the past year, Provident executed its previously described portfolio
strategies, balanced with identifying and building upon key in-market
relationships. Clear business and portfolio strategies provided focus to
relationship marketing and aggressive disposition of non-strategic portfolios
and problem loans.
The year ended 2003 resulted in marked change in the portfolio's composition. A
balance of risk and return, reduced volatility, and portfolio and franchise
suitability were important drivers of the change. Provident completed its
desired reduction of cash flow lending, culminated by the fourth quarter
accelerated sale of non-performing loans, the fourth quarter sale of a
significant amount of commercial airline exposure and the second quarter sale of
the nonconforming residential mortgage portfolio. Provident continues to
emphasize growth in its regional middle-market commercial lending, middle-market
leasing and prime home equity businesses as management believes these loans will
generate more predictable future earnings streams.
Enhanced processes have improved management's understanding of the portfolios
and the value of the continuing businesses and relationships. Active use of an
independent Special Assets Division, Portfolio Risk Review, and an expanded
Senior Credit Officer network allow Provident to ensure independent oversight
and improved communication of issues and problems throughout the portfolio. In
addition, Credit and Risk Management is responsible for establishing and
overseeing Provident's credit risk policies addressing underwriting standards,
internal lending limits and methodologies for monitoring credit risk within the
various loan and lease portfolios. These policies have enhanced initial and
ongoing risk management and monitoring capabilities.
Provident's analytical and reporting capacity provides timely and valuable
portfolio information. Loans and leases are primarily monitored by closely
following changes and trends in risk characteristics. The characteristics are
analyzed using various techniques, including: credit scoring models for consumer
and small business loans and leases and risk ratings for larger commercial,
commercial mortgage and commercial construction loans and leases. Risk ratings
are assigned based upon individual credit analysis and are aggregated for
reporting to senior management on a regular basis. Various analytics are the
basis for establishing portfolio wide targets and caution levels. Early trends
and thresholds trigger modifications in strategy and tactics including the use
of secondary market alternatives to liquidate and mitigate problem exposures and
portfolio segments.
Provident maintains a reserve for loan and lease losses to absorb losses from
current outstandings and potential usage of unfunded commitments. Discussion and
analysis of the estimates of losses as well as the overall credit quality of the
off-balance sheet lending portfolio is provided in Note 3 of the "Notes to
Consolidated Financial Statements." The following paragraphs provide information
concerning its on-balance sheet credit portfolio and unused commitments.
The reserve for loan and lease losses is maintained at a level which management
considers adequate to absorb inherent loan and lease losses given the conditions
at the time. The reserve is increased by the provision for
27
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
loan and lease losses. Loans and leases deemed uncollectible are charged off and
deducted from the reserve while recoveries on loans and leases previously
charged off are added back to the reserve.
The adequacy of the reserve for loan and lease losses is monitored on a regular
basis and reflects management's evaluation of numerous factors. These factors
include the quality of the current loan portfolio, the trend in the loan
portfolio's risk ratings, current economic conditions, specific industry trends,
loan concentrations, evaluation of specific loss estimates for all significant
problem loans, payment histories, collateral valuations, historic charge-off and
recovery experience, estimates of charge-offs for the upcoming year and other
pertinent information. Based upon the analyses and the improved credit risk
profile of the loan portfolio, Provident lowered its loan loss reserve to total
loans by 40 basis points to 1.80% during 2003 after lowering the reserve ratio
by 49 basis points in 2002.
Unfavorable business conditions and difficulties experienced by the airline
industry have caused Provident to take large loan loss provisions during the
past several years. Late in the fourth quarter of 2000, Provident placed three
large loans, totaling $52 million, on nonaccrual status. Additionally, several
large commercial loan charge-offs were recorded at that time. Nonaccrual loans
and charge-offs increased during 2001 as the economic climate continued to
deteriorate, particularly with regard to the airline industry. During 2001,
Provident recorded charge-offs, write-downs and additional provision of $66
million on commercial airline loans and leases. Another $15 million of provision
was recorded for industries other than commercial airlines that were related to
the events of September 11, 2001. During 2002, Provident recorded an additional
$34 million of credit costs related to the airline industry. Although the
economy remained sluggish during 2002, credit-related volatility began to
stabilize. During 2003, nonperforming assets declined $98.1 million and the
overall credit quality of the loan and lease portfolio improved dramatically.
This was due primarily to several related strategic actions taken during 2003,
including the second quarter sale of nearly all the subprime residential
mortgage loan portfolio and a substantial portion of its foreclosed properties,
and the fourth quarter sale of approximately $112 million of commercial loans
and leases, many of which involved financing to the commercial airline industry.
Included in the fourth quarter sale were approximately $38 million of
nonperforming assets. Additionally, Provident recorded $36 million of credit
costs related to the airline industry. As a result of the decline in
nonperforming assets, both the reserve to nonaccrual loans and nonperforming
assets ratios improved during 2003.
28
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following table shows selected information relating to Provident's reserve
for loan and lease losses:
December 31,
------------------------------------------------------------
(In Thousands) 2003 2002 2001 2000 1999
- ------------------------------ -------- -------- -------- -------- --------
Reserve for Loan and Lease
Losses at Beginning of Period $201,051 $241,143 $159,118 $ 95,181 $ 80,179
Provision Charged to Expense 115,979 99,549 215,545 133,477 46,110
Acquired Reserves -- -- 10,003 2,377 1,263
Loans and Leases Charged Off:
Corporate Lending:
Commercial 58,446 81,371 105,711 63,497 25,145
Mortgage 1,200 183 844 96 247
Construction 117 850 -- -- --
Lease Financing 48,131 48,501 26,622 2,892 6,736
Consumer Lending:
Installment 8,185 7,727 7,557 7,535 10,159
Residential 61,006 27,229 14,846 8,022 759
Lease Financing 89 -- -- -- --
-------- -------- -------- -------- --------
Total Charge-Offs 177,174 165,861 155,580 82,042 43,046
-------- -------- -------- -------- --------
Recoveries:
Corporate Lending:
Commercial 7,314 10,274 2,675 3,406 2,742
Mortgage 38 137 8 20 42
Construction 297 21 -- -- --
Lease Financing 7,083 9,821 3,068 1,290 3,102
Consumer Lending:
Installment 3,021 4,615 4,990 5,282 4,523
Residential 2,372 1,352 1,316 127 266
Lease Financing 19 -- -- -- --
-------- -------- -------- -------- --------
Total Recoveries 20,144 26,220 12,057 10,125 10,675
-------- -------- -------- -------- --------
Net Loans and Leases
Charged Off 157,030 139,641 143,523 71,917 32,371
-------- -------- -------- -------- --------
Reserve for Loan and Lease
Losses at End of Period $160,000 $201,051 $241,143 $159,118 $ 95,181
======== ======== ======== ======== ========
On a percentage basis, the following table provides annual net charge-offs to
average total loans and leases by category:
December 31,
------------------------------------------------------------
2003 2002 2001 2000 1999
------- ------- ------- ------- -------
Corporate Lending:
Commercial 1.17% 1.65% 2.21% 1.38% .63%
Mortgage .12 .01 .10 .01 .04
Construction (.03) .15 -- -- --
Lease Financing 3.27 3.23 2.46 .42 1.29
Consumer Lending:
Installment .35 .30 .33 .44 .96
Residential 22.04 3.51 1.34 2.04 .05
Lease Financing .04 -- -- -- --
------- ------- ------- ------- -------
Net Charge-Offs to Average
Total Loans and Leases 1.73% 1.59% 1.63% 1.04% .51%
======= ======= ======= ======= =======
Explanation as to significant changes in charge-offs follows:
- - Commercial: Net charge-offs to average loans were 1.17%, 1.65% and 2.21%
for 2003, 2002 and 2001, respectively. The decrease in charge-offs in both
2003 and 2002 was due primarily to a decrease in net charge-offs in the
structured finance area, which is being de-emphasized. The increase in
charge-offs for 2001 was due primarily to the overall deterioration in the
economy, particularly in the airline industry. The increase in charge-offs
29
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
in 2000 was due primarily to the decline in asset quality indicators
combined with the uncertain economic environment.
- - Commercial Lease Financings: Net charge-offs to average leases were 3.27%,
3.23% and 2.46% for 2003, 2002 and 2001, respectively. The higher level of
net charge-off percentage during 2003 and 2002 was due primarily to an
increase in charge-offs related to aircraft exposures.
- - Residential: Net charge-offs to average loans were 22.04%, 3.51% and 1.34%
for 2003, 2002 and 2001, respectively. The increase in charge-offs for
2003 was due primarily to the $49.2 million charge-off taken in
conjunction with the sale of $471 million of subprime residential mortgage
loans that occurred during the second quarter of 2003. The increase in
charge-offs for 2002 was due primarily to the $9.1 million charge-off
taken in conjunction with the sale of $27 million of nonperforming
residential mortgage loans that took place during the second quarter of
2002. The increase in charge-offs for 2001 and 2000 was a result of
nonconforming residential loans originated during the second half of 2000
and the first half of 2001 being kept on the balance sheet.
The following table shows the dollar amount of the reserve for loan and lease
losses, using management's estimate, by principal loan and lease category. While
amounts are allocated to various portfolio categories, the total reserve, less
the portion attributable to reserves as prescribed under provisions of Statement
No. 114, "Accounting by Creditors for Impairment of a Loan," is available to
absorb losses from any loan or lease category.
December 31,
------------------------------------------------------------
(In Thousands) 2003 2002 2001 2000 1999
- ------------------ -------- -------- -------- -------- --------
Corporate Lending:
Commercial $104,486 $132,286 $168,248 $107,713 $ 73,992
Mortgage 11,784 12,337 5,837 8,291 4,645
Construction 4,575 5,393 7,430 5,622 2,192
Lease Financing 30,694 28,690 26,303 13,407 4,344
-------- -------- -------- -------- --------
151,539 178,706 207,818 135,033 85,173
Consumer Lending:
Installment 3,919 1,490 5,696 9,089 8,245
Residential 3,298 20,855 27,629 14,996 1,763
Lease Financing 1,244 -- -- -- --
-------- -------- -------- -------- --------
8,461 22,345 33,325 24,085 10,008
-------- -------- -------- -------- --------
$160,000 $201,051 $241,143 $159,118 $ 95,181
======== ======== ======== ======== ========
The reserves related to both corporate lending and consumer lending declined
during 2003 due to the reduction in nonperforming assets and improvement in the
risk profile of the lending portfolio. The changes in the corporate lending
reserves and their distribution between 2001 and 2002 resulted from numerous
factors, including: (1) the anticipated use of the reserves established as of
December 31, 2001 to absorb potential charge-offs in the commercial portfolio
stemming from the commercial airline industry as well as several unrelated
potential charge-offs in other industries; (2) the implementation of an enhanced
commercial-related reserve methodology; and (3) the transfer of several
commercial construction loans to commercial mortgage loan status. Additionally,
the reserves related to consumer lending declined due to the sale of higher risk
assets.
30
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The reserve levels are tested under various scenarios, primarily reflecting
different portfolio migration and roll rates. The rates used reflect those
experienced during periods of varied economic conditions. As would be expected,
the results indicate additional provision may be required to maintain adequate
reserves if the downside scenarios were to materialize.
The following table presents a summary of various indicators of credit quality:
December 31,
----------------------------------------------------------------
(Dollars In Thousands) 2003 2002 2001 2000 1999
- ------------------------------- -------- -------- -------- -------- --------
Nonaccrual Loans:
Corporate Lending:
Commercial $ 62,288 $ 99,805 $116,663 $ 74,401 $ 43,452
Mortgage 8,146 11,783 1,929 1,712 3,003
Construction 2,469 1,746 2,699 -- 216
Lease Financing 514 4,008 7,986 6,503 1,309
-------- -------- -------- -------- --------
73,417 117,342 129,277 82,616 47,980
Consumer Lending:
Installment -- -- -- -- 48
Residential 6,442 49,091 47,579 13,404 7,640
-------- -------- -------- -------- --------
6,442 49,091 47,579 13,404 7,688
-------- -------- -------- -------- --------
Total Nonaccrual Loans 79,859 166,433 176,856 96,020 55,668
Other Nonperforming Assets 4,299 15,780 20,907 8,805 3,870
-------- -------- -------- -------- --------
Total Nonperforming Assets $ 84,158 $182,213 $197,763 $104,825 $ 59,538
======== ======== ======== ======== ========
Loans 90 Days Past Due -
Still Accruing $ 12,702 $ 29,918 $ 30,326 $ 28,203 $ 14,943
Loan and Lease Loss Reserve to:
Total Loans and Leases 1.80% 2.20% 2.69% 1.99% 1.43%
Nonaccrual Loans 200.35 120.80 136.35 165.71 170.98
Nonperforming Assets 190.12 110.34 121.94 151.79 159.87
Nonaccrual Loans to
Total Loans and Leases .90 1.82 1.98 1.20 .84
Nonperforming Assets to:
Total Loans, Leases and
Other Nonperforming Assets .95 1.99 2.20 1.31 .90
Total Assets .49 1.04 1.19 .70 .50
Loans and leases are generally placed on nonaccrual status when the payment of
principal and/or interest is past due 90 days or more. However, installment
loans and consumer finance leases are not placed on nonaccrual status because
they are charged off in the month the loans and leases reach 120 days past due.
In addition, loans that are well secured and in the process of collection are
not placed on nonaccrual status. When a loan is placed on nonaccrual status, any
interest income previously recognized that has not been received is reversed
from income. Future interest income is recorded only when a payment is received
and collection of principal is considered reasonably assured.
Although loans and leases may be classified as nonaccrual, many continue to pay
interest irregularly or at less than the original contractual rates. The gross
amount of interest income recognized during 2003 with respect to these loans and
leases was $0.9 million compared to $12.5 million that would have been
recognized had the loans and leases remained current in accordance with their
original terms.
31
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Loans and leases that have been placed on nonaccrual status are further
evaluated for potential losses based upon review and discussion among Credit,
Portfolio Risk Review, lending officers, collection associates, and senior
management. Factors considered include the market value of collateral associated
with a specific loan or lease, cash flows generated by the borrower, third-party
guarantees, the general economic climate and any specific industry trends that
may affect an individual loan or lease. Total nonaccrual loans at December 31,
2003 were $79.9 million. In addition, $50.5 million of performing loans were
being closely monitored due to possible credit problems.
Nonaccrual loans decreased $86.6 million and other nonperforming assets
decreased $11.5 million during 2003 while nonaccrual loans decreased $10.4
million and other nonperforming assets decreased $5.1 million during 2002. The
following table shows the progression of nonaccrual loans and other
nonperforming assets during these time periods:
Corporate Lending
--------------------------------------- Consumer Total Other Total
Real Lease Residential Nonaccrual Nonperforming Nonperforming
(In Thousands) Commercial Estate Financing Mortgages Loans Assets Assets
- -------------- ---------- ------ --------- --------- ----- ------ ------
Balance at
January 1, 2002 $ 116,663 $ 4,628 $ 7,986 $ 47,579 $ 176,856 $ 20,907 $ 197,763
Additions 108,021 12,147 15,757 75,133 211,058 4,012 215,070
Payments / Sales (51,503) (2,023) (5,136) (27,376) (86,038) (20,345) (106,383)
Charge-Offs (73,076) (1,033) (14,599) (23,055) (111,763) (4,481) (116,244)
Transfers to Other
Nonperforming Assets (300) (190) -- (23,190) (23,680) 23,680 --
Write-Downs -- -- -- -- -- (7,993) (7,993)
--------- --------- --------- --------- --------- --------- ---------
Balance at
December 31, 2002 99,805 13,529 4,008 49,091 166,433 15,780 182,213
Additions 60,653 6,450 1,194 35,613 103,910 9,629 113,539
Payments / Sales (44,220) (7,819) (1,718) (51,838) (105,595) (34,848) (140,443)
Charge-Offs (53,858) (1,317) (1,570) (8,073) (64,818) (3,103) (67,921)
Transfers to Other
Nonperforming Assets (92) (228) (1,400) (18,351) (20,071) 20,071 --
Write-Downs -- -- -- -- -- (3,230) (3,230)
--------- --------- --------- --------- --------- --------- ---------
Balance at
December 31, 2003 $ 62,288 $ 10,615 $ 514 $ 6,442 $ 79,859 $ 4,299 $ 84,158
========= ========= ========= ========= ========= ========= =========
Noninterest Earning Assets
Leased equipment includes the leasing of automobiles to consumers and equipment
to commercial customers. As of December 31, 2003 and 2002, the cost of
automobiles, net of depreciation, was $1.4 billion and $2.1 billion,
respectively, and the cost of equipment, net of depreciation, was $245 million
and $266 million, respectively. The decrease in auto leases is due to the
amortization of the portfolio. Also, auto leases originated since February 2003
are classified as direct financing leases in the loan category as Provident
changed the structure of the residual insurance it obtains on its auto leases.
The sale of equipment leases is the primary reason for the decrease in equipment
leases.
Goodwill totaled $82 million and $83 million as of December 31, 2003 and 2002,
respectively. Goodwill represents the excess of the purchase price over net
identifiable tangible and intangible assets acquired in a purchase business
combination. Provident adopted the provisions of Statement of Financial
Accounting Standards (Statement) No. 141, "Business Combinations," and No. 142,
"Goodwill and Other Intangible Assets," on January 1, 2002. Under the new rules,
goodwill and intangible assets deemed to have indefinite lives are no longer
amortized but are subject to annual impairment tests in accordance with
Statement 142. Management performed an impairment test on its
32
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
goodwill assets as of January 1, 2003 and determined that no impairment existed
as of that date. Other intangible assets continue to be amortized over their
useful lives. Additional information on goodwill and other intangibles is
provided in Note 8 of the "Notes to Consolidated Financial Statements."
Other assets decreased $67 million during 2003 and increased $41 million during
2002. The decrease in 2003 was primarily due to a decrease in the amount of
market value adjustments recorded in relation to Statement No. 133 "Accounting
for Derivative Instruments and Hedging Activities." The increase in 2002 was due
primarily to an increase in the amount of market value adjustments recorded in
relation to Statement No. 133.
Deposits
Deposits increased $487 million and $995 million during 2003 and 2002,
respectively. Deposits increased during 2003 despite a reduction of
approximately $883 million from the sale of Provident's Florida deposits that
occurred during the fourth quarter of 2003. Excluding the sale of Florida
deposits, average retail and commercial deposits increased 10% during 2003.
During 2002, commercial deposits increased 68% to $1.1 billion at December 31,
2002 from $637 million at December 31, 2001. The following table presents a
summary of period end deposit balances:
December 31,
--------------------------------
(In Millions) 2003 2002 2001
- ------------- ---- ---- ----
Noninterest Bearing Deposits $ 1,491 $ 1,142 $ 995
Interest Bearing Demand Deposits 902 1,017 523
Savings Deposits 1,639 1,460 1,544
Certificates of Deposit Less than $100,000 1,828 2,621 2,551
Certificates of Deposit of $100,000 or More 4,476 3,609 3,241
------- ------- -------
$10,336 $ 9,849 $ 8,854
======= ======= =======
At December 31, 2003, maturities on certificates of deposit of $100,000 or more
were as follows (in millions):
3 months or less $ 307
Over 3 through 6 months 159
Over 6 through 12 months 273
Over 12 months 3,737
------
Total $4,476
======
Included in certificates of deposit of $100,000 or more at December 31, 2003,
2002 and 2001 were brokered deposits of $3.8 billion, $2.7 billion and $2.0
billion, respectively.
Provident issues brokered certificates of deposit with embedded call options
combined with interest rate swaps with matching call dates as part of its
certificate of deposit program. Provident has the right to redeem the
certificates of deposit on specific dates prior to their stated maturity while
the interest rate swaps are callable at the option of the swap counterparty. The
terms and conditions of the call options embedded in the interest rate swaps
match those of the certificates of deposit, offsetting any option risk exposure
to Provident. At December 31, 2003, Provident had $2.1 billion of brokered
callable certificates of deposit.
33
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Borrowed Funds
Borrowed funds are an important component of total funds necessary to support
earning assets. In 2003, short-term debt decreased $482 million (25%) while
long-term debt decreased $544 million (14%). A decrease in federal funds
purchased and repurchase agreements was the primary reason for the decrease in
short-term debt. Prepayment of Federal Home Loan Bank borrowing and payments on
subordinated debt and debt issued as secured financings were the primary reasons
for the decrease in long-term debt. In 2002, short-term debt increased $40
million (2%) while long-term debt decreased $239 million (6%). An increase in
commercial paper borrowing was the primary reason for the increase in short-term
debt. Payments on medium-term notes and debt issued as secured financing were
the primary reasons for the decrease in long-term debt.
Minority Interest
During June 2002, Provident and its consolidated subsidiary, PFGI Capital
Corporation (PFGI Capital), issued 6.6 million of equity units (PRIDES) to
outside investors for $165 million. Provident Bank owns all of the $165 million
of Common Stock of PFGI Capital. The principal business objective of PFGI
Capital is to hold and manage commercial mortgage loan assets and other
authorized investments acquired from Provident Bank that will generate net
income for distribution to its stockholders. PFGI Capital has elected to be
treated as a real estate investment trust (REIT) for federal income tax
purposes.
Each PRIDES is comprised of two components - a 3-year forward purchase contract
and PFGI Capital Preferred Stock. Each forward purchase contract obligates the
holder to buy, on August 17, 2005, for $25, a number of newly issued shares of
Provident Common Stock equal to the "settlement rate." The PRIDES qualify as
Tier 1 Capital for regulatory capital purposes. Additional information
concerning the PRIDES instruments is provided in Note 13 of the "Notes to
Consolidated Financial Statements."
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
Asset Securitization Activity
From 1996 through the second quarter of 2000, the structure of some of
Provident's securitizations resulted in the transactions being accounted for as
sales through the use of special purpose entities. As such, gains or losses were
recognized, loans and leases were removed from the balance sheet and residual
interest, representing the present value of future cash flows, was recorded.
During the third quarter of 2000, management decided to structure all future
securitizations as secured financings thereby eliminating the use of
gain-on-sale accounting and leaving all debt on the balance sheet.
34
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
In December 2003, revised FASB Interpretation No. 46, "Consolidation of Variable
Interest Entities" (FIN 46R) was issued. FIN 46R addresses consolidation by
business enterprises of variable interest entities (VIEs). A VIE exists when (1)
the equity investment at risk is not sufficient to permit the entity to finance
its activities without additional subordinated financial support; (2) equity
investors do not have the ability to make decisions about the entity's
activities through voting rights or do not have the obligation/right to absorb
expected losses/residual returns of the entity; or (3) equity investors have
voting rights that are not proportionate to their economic interests and the
activities of the entity are conducted on behalf of an investor with a
disproportionately small voting interest. FIN 46R requires VIEs to be
consolidated by their primary beneficiaries. The primary beneficiary of a VIE is
the party that absorbs a majority of the entity's expected losses and/or
receives a majority of its expected residual returns as a result of holding
variable interests.
FIN 46R does not apply to qualifying special purpose entities (QSPE) as
described in Statement 140, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities." The securitization trusts created as
a result of these securitization transactions, with the exception of Provident
Bank Home Equity Loan Trust 1996-1 and 1996-2 (PCFS 96-1 and PCFS 96-2), meet
the applicable QSPE criteria under Statement 140.
As loans were sold to the PCFS 96-1 and PCFS 96-2 securitization trusts prior to
the effective date of Statement No. 125, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities," the securitization
trusts do not meet the definition of a QSPE and are now required to be
consolidated in Provident's financial statements as of December 31, 2003 based
on the provisions of FIN 46R. The consolidation of PCFS 96-1 and 96-2
securitization trusts resulted in an additional $14.1 million in loans being
recorded on Provident's balance sheet and an after-tax cumulative effect of
changes in accounting principles of $1.2 million being charged against earnings.
Securitization trusts created from 1997 to 2000 have not been consolidated. As
such, loans and leases sold to these securitization trusts are not included on
Provident's balance sheet. The following table provides a summary of the
outstanding balances of these off-balance sheet managed assets:
December 31,
----------------------------------------
(In Thousands) 2003 2002 2001
- ------------------------- ---------- ---------- ----------
Nonconforming Residential $1,169,763 $1,779,127 $2,627,332
Prime Home Equity 133,472 194,775 303,527
Equipment Leases 41,363 94,408 207,131
---------- ---------- ----------
$1,344,598 $2,068,310 $3,137,990
========== ========== ==========
In connection with the sale of these loans and leases, Provident recorded
retained interest in securitized assets (RISAs), issued an unfunded secured
demand note and established credit enhancing collateral accounts. RISAs
represent the rights to future cash flows arising after the investors of the
securitization trusts have received the return for which they contracted. RISAs
are subordinate to investors of the securitization trust with its value subject
to prepayment risks, interest rate risks and credit risks on the transferred
assets. As of December 31, 2003, Provident's nonconforming residential RISAs
totaled $213.0 million, which included the fair value of
35
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
the unfunded note of $97.6 million, and its Prime Home Equity RISAs totaled $6.4
million.
Provident has provided a liquidity commitment to its nonconforming residential
securitizations, treated as sales for financial reporting purposes, in the form
of an unfunded secured demand note backed by a AAA rated standby letter of
credit. The commitment is maintained in order to improve the credit grade of the
securitization and thereby reduce the rate paid to investors of the
securitization trust. As of December 31, 2003, the secured demand note could be
drawn up to $181 million.
Estimates of future losses on nonconforming residential securitizations are
$60.1 million which are considered in estimating the fair value and carrying
value of the RISA balance. Information concerning valuation analyses of the
RISAs, may be found in "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Critical Accounting Policies." Information
concerning the credit quality of the off-balance sheet loans and leases, as well
as additional details of the RISAs and credit collateral accounts is provided in
Note 3 of "Notes to Consolidated Financial Statements."
Provident's prime home equity and equipment lease securitizations, also treated
as sales, provide for the maintenance of cash collateral within the
securitization structure as additional collateral for investors. The collateral
is maintained at a significantly higher balance than the level of estimated
credit losses to improve the credit grade of the securitization and thereby
reduce the rate paid to investors of the securitization trust. As of December
31, 2003, $67.8 million of cash was being held in deposit accounts for this
purpose of which $34.5 million is held at Provident and is included in deposit
liabilities. As of year-end 2003, Provident estimates future losses of $833,000
will arise in the home equity and equipment leasing securitizations.
Fannie Mae DUS Program
Red Mortgage Capital, Inc. (Red Mortgage), a member of Red Capital Group, is an
approved Fannie Mae Delegated Underwriting and Servicing (DUS) mortgage lender.
Under the Fannie Mae DUS program, Red Mortgage underwrites, funds and sells
mortgage loans on multifamily rental projects. Red Mortgage then services these
mortgage loans on Fannie Mae's behalf. Participation in the Fannie Mae DUS
program requires Red Mortgage to share the risk of loan losses with Fannie Mae.
The substance of this loss sharing arrangement is that Red Mortgage and Fannie
Mae split losses with one-third of all losses assumed by Red Mortgage and
two-thirds of all losses assumed by Fannie Mae.
Red Mortgage services multifamily mortgage loans under the DUS program with
outstanding principal balances aggregating approximately $3.8 billion and $3.0
billion at December 31, 2003 and 2002, respectively. Red Mortgage has
established reserves of approximately $10.9 million and $8.7 million as of
December 31, 2003 and 2002, respectively, for possible losses under this
program. The reserve is determined by evaluating pools of homogenous loans and
includes information based upon property type and historical loss experience, as
well as the underlying collateral's recent operating performance. Management
believes the reserve is maintained at a level that adequately provides for the
inherent losses that would accrue to Red
36
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Mortgage through its portfolio of DUS loans. At December 31, 2003, one DUS loan
with $13.1 million in unpaid principal balance, was in payment default. The
employees and management team of Red Mortgage have originated and serviced the
existing Fannie Mae DUS loan servicing portfolio since 1995 without any
charge-offs relating to the DUS loans.
Interest Rate Swaps and Caps
At December 31, 2003, Provident held $5.4 billion in interest rate swaps on
which it receives payments at fixed interest rates while making payments at
variable interest rates. These instruments are used primarily as a hedge to
offset time deposit accounts and debt where Provident must pay interest at fixed
rates. These derivatives essentially convert long-term fixed rate instruments
into shorter repricing instruments.
Provident also had $1.5 billion in interest rate swaps that it receives payments
at floating interest rates while making payments at fixed interest rates. The
primary use of these instruments is for off-balance sheet securitizations.
Provident is required to pay investors of these securitizations interest at a
floating rate, however, many of the underlying loans pay interest to Provident
at fixed or longer-term adjustable rates. The use of these interest rate swaps
allows Provident to offset the floating interest rate payments to the investors
with floating interest rates payments received from the interest rate swaps. The
fixed or longer-term adjustable interest rate payments received from the
underlying loans are used to offset the fixed rate interest payments required on
these interest rate swaps.
Provident has simultaneously purchased and sold approximately $2.5 billion in
interest rate caps, predominantly related to off-balance sheet mortgage
securities. Interest rate caps protect against the impact of rising interest
rates on interest-bearing financial instruments. When interest rates go above a
cap's strike rate, the cap provides for receipt of payments based on its
notional amounts.
The fair value of these interest rate swaps and caps are recorded on the
consolidated balance sheet as either other assets (derivatives with a positive
fair value) or as other liabilities (derivatives with a negative fair value) as
prescribed by Statement No. 133, "Accounting for Derivative Instruments and
Hedging Activities." For further details concerning Provident's interest rate
swaps and caps, see Note 19 of "Notes to Consolidated Financial Statements."
Forward Delivery Commitments
Provident enters into forward delivery contracts for the future delivery of
commercial real estate and residential mortgage loans at a specified interest
rate to reduce the interest rate risk associated with loans held for sale. As of
December 31, 2003, Provident had $74 million in forward delivery contracts.
Credit Risk Transfer Instruments
During 2001 and 2000, Provident entered into two credit risk transfer
transactions related to its auto lease originations. Both transactions are
designed to reduce Provident's exposure to credit losses. Under the 2000
37
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
transaction, Provident transferred a substantial part of credit-related losses,
beyond a retained first loss piece, related to the then outstanding auto lease
pool. Similarly, the 2001 transaction enabled Provident to transfer a large
portion of its credit risk exposure related to its auto lease pool originated
during that year. As a result of these transactions, Provident was able to lower
its credit concentration in auto leasing while reducing its regulatory capital
requirements. As of December 31, 2003, the remaining unpaid auto lease balances
on the 2001 and 2000 credit risk transfer transactions were $0.4 billion and
$0.6 billion, respectively.
Credit Commitments, Standby Letters of Credit and Guarantees
Commitments to extend credit are financial instruments in which Provident agrees
to provide financing to customers based on predetermined terms and conditions.
Since many of the commitments to extend credit are expected to expire without
being drawn upon, the total commitment amounts do not necessarily represent
future cash requirements. As of December 31, 2003 and 2002, credit commitments
totaled $4.6 billion and $2.9 billion, respectively.
Standby letters of credit are primarily issued to support public and private
borrowing arrangements, including commercial paper, bond financing, and similar
transactions. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
Provident had $248 million and $274 million in standby letters of credit as of
December 31, 2003 and 2002, respectively.
Provident Bank has issued a guarantee for a subsidiary to assist in its business
activities. This guarantee was made to Fannie Mae for the benefit of Red
Mortgage. Red Mortgage is an approved Fannie Mae Delegated Underwriting and
Servicing (DUS) mortgage lender. Participation in the Fannie Mae DUS program
requires Red Mortgage to share the risk of loan losses with Fannie Mae. For Red
Mortgage to participate in the Fannie Mae DUS program, Provident Bank provided a
guarantee to Fannie Mae that it would fulfill all payments required of Red
Mortgage under the loss sharing arrangement if Red Mortgage fails to meet its
obligations. The guarantee will continue until such time as the loss sharing
agreement is amended or Red Mortgage no longer shares the risk of loan losses
with Fannie Mae. The fair value of the guarantee, in the form of reserves for
losses under the Fannie Mae DUS program, has been established on Red Mortgage's
balance sheet. Additional information concerning the Fannie Mae DUS program may
be found under "Management Discussion and Analysis of Financial Condition and
Results of Operations - Fannie Mae DUS Program."
Liquidity
Adequate liquidity is necessary to meet the borrowing needs and deposit
withdrawal requirements of customers as well as to satisfy liabilities, fund
operations, support asset growth and pay dividends to shareholders. Management
forecasts that the largest liquidity needs during 2004 will come from growth in
the lending portfolio, maturing of retail and brokered certificates of deposit
and scheduled principal payments on long-term debt. Provident has a variety of
sources to meet these liquidity demands. First, management expects to issue new
certificates of deposit along with renewing many of its maturing certificates of
deposit. Management also projects growth within retail deposits and a decrease
in federal funds sold and reverse
38
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
repurchase agreements. Additional sources of liquidity include the secured
financing of commercial and consumer loans and leases, whole-loan sales of
nonconforming residential loans and home equity loans and the availability to
borrow both short-term and long-term funds.
The following table represents Provident's estimated contractual obligations,
excluding short-term obligations, at December 31, 2003:
Less Than From 1 to From 3 to More Than
(In Millions) 1 Year 3 Years 5 Years 5 Years Total
- ------------- ------ ------- ------- ------- -----
Certificates of Deposit $ 1,372 $ 1,617 $ 975 $ 2,340 $ 6,304
Long-Term Debt 498 1,725 402 674 3,299
Junior Subordinated Debentures -- -- -- 466 466
Rental Obligations 15 27 22 50 114
------- ------- ------- ------- -------
$ 1,885 $ 3,369 $ 1,399 $ 3,530 $10,183
======= ======= ======= ======= =======
Provident does not have a significant amount of purchase obligations.
Information about Provident's off-balance sheet obligations, which cannot be
forecast as to dollar or time interval of payment, is discussed in the sections
titled "Asset Securitization Activity," "Interest Rate Swaps and Caps," "Forward
Delivery Commitments" and "Credit Commitments, Standby Letters of Credit and
Guarantees."
Consistent with Provident's contingent funding plan, management monitors the
potential impact of changes in its corporate ratings on existing and new
business transactions. Ratings related liquidity events may include reduced
availability of short-term federal funds, reduced availability to the surety
bond market that supports Provident Bank's Public Funds program and other
commitments provided to third parties in related business transactions. If such
ratings events are anticipated, management will take actions to enhance balance
sheet liquidity positions to meet liquidity needs. Such actions to enhance
liquidity positions were taken in connection with Provident's March 5, 2003
announcement related to the restatement of its earnings. In anticipation of
potential ratings downgrades, management took actions to enhance liquidity
positions, including issuance of additional brokered certificates of deposits.
Additional term liquidity reduces reliance on short-term funding and increases
the availability of collateral in the investment portfolio. Management will
continue to monitor events as the need may arise for further liquidity
enhancements in the future.
The parent company's primary liquidity needs during 2004 will be the payment of
dividends to its preferred and common shareholders, funds for activity of the
commercial paper operations and interest payments on junior subordinated
debentures. The major source of liquidity for the parent company is dividends
and interest paid to it by its subsidiaries. Provident received dividends of $65
million, $45 million and $15 million in 2003, 2002 and 2001, respectively. The
amount of dividends available for payment in 2004 by Provident Bank is
approximately $95.1 million, plus 2004 net income.
The parent company also received interest payments of $24.2 million, $25.4
million and $24.9 million for the years ended December 31, 2003, 2002 and 2001,
respectively, from its subsidiaries. These interest payments were primarily the
result of $249.5 million of subordinated debt loaned to Provident Bank. The
subordinated debt matures during 2009 and 2010. Management believes that
dividends and interest payments from Provident Bank
39
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
will be sufficient to meet the parent company's liquidity requirements in 2004.
Funding for the sale of the Florida deposits, loans and branches, which occurred
in the fourth quarter of 2003, came from proceeds from the second quarter sale
of subprime residential mortgage loans, repayments on and sales of investment
securities, and from general corporate funding.
CAPITAL RESOURCES
Total stockholders' equity at December 31, 2003 and 2002 was $899 million and
$880 million, respectively. The change in the equity balance relates primarily
to net income exceeding dividends by $48 million, an increase in the market
value of cash flow hedging instruments of $30 million (net of deferred taxes)
and a decrease in the market value of investment securities of $67 million, (net
of deferred taxes).
Provident's capital expenditure program typically includes the purchase of
computer equipment and software, branch additions and enhancements, ATM
additions and office building renovations. Capital expenditures for 2004 are
estimated to be approximately $31 million and include the purchase of data
processing hardware and software, branch additions, renovations and
enhancements, facility renovations and ATMs. Management believes that currently
available funds and funds provided by normal operations will be sufficient to
meet these capital expenditure requirements.
The following table of ratios is important for an analysis of capital adequacy:
Year Ended December 31,
-------------------------------
2003 2002 2001
------- ------- -------
Average Shareholders' Equity to Average Assets 5.00% 5.12% 5.59%
Average Tangible Shareholders' Equity to
Average Tangible Assets 4.49 4.55 5.00
Period End Shareholders' Equity to Period End Assets 5.28 5.02 4.84
Period End Tangible Shareholders' Equity to
Period End Tangible Assets 4.79 4.49 4.26
Dividend Payout to Net Earnings 50.16 50.64 n/m
Tier 1 Capital to Risk-Weighted Assets 10.59 9.40 7.95
Total Risk-Based Capital To Risk-Weighted Assets 12.44 11.42 10.71
Tier 1 Leverage Ratio 8.13 7.81 6.65
- ----------
n/m - not meaningful
Risk-based capital guidelines established by the Federal Reserve Board set
minimum capital requirements and require institutions to calculate risk-based
capital ratios by assigning risk weightings to assets and off-balance sheet
items. Provident is required to maintain minimum ratios of 4.00% for Tier 1
capital to average assets, 4.00% for Tier 1 capital to risk-weighted assets, and
8.00% for total risk-based capital to risk-weighted assets. These guidelines
further define "well-capitalized" levels for Tier 1, total risk-based capital,
and leverage ratio purposes at 6%, 10% and 5%, respectively. Provident has
consistently maintained regulatory capital ratios at or above the
well-capitalized standards. For further detail on capital ratios, see Note 15 of
the "Notes to Consolidated Financial Statements."
40
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
As noted in earlier sections of this report, during the second quarter of 2002,
Provident issued $165 million of PRIDES in connection with the formation of PFGI
Capital. These equity units qualify as Tier 1 Capital in Provident's calculation
of regulatory capital ratios.
CRITICAL ACCOUNTING POLICIES
Note 1 to the "Notes to Consolidated Financial Statements" lists significant
accounting policies used in the development and presentation of Provident's
financial statements. However, four of these accounting policies are considered
to be critical due to the level of sensitivity and subjectivity of their
underlying accounting estimates. These critical accounting policies concern the
reserve for loan and lease losses; securities; mortgage servicing assets; and
derivative financial instruments.
Adequacy of the Reserve for Loan and Lease Losses: Provident maintains a reserve
to absorb potential loan and lease losses inherent in its lending portfolio.
Management's determination of the adequacy of the loan loss reserve is based on
an assessment of the potential losses given the conditions at the time. This
assessment consists of certain loans and leases being evaluated on an individual
basis, as well as all loans and leases being categorized based on common credit
risk attributes and being evaluated as a group. Management evaluates numerous
factors including the credit quality of the current loan portfolio, the trend in
the loan portfolio's risk ratings, current economic conditions, specific
industry trends, loan concentrations, evaluation of specific loss estimates for
all significant problem loans, payment histories, collateral valuations,
historical charge-off and recovery experience, estimates of charge-offs for the
upcoming year and other relevant information.
Loans and leases that have been placed on classified and/or nonaccrual status
are further evaluated for potential losses based upon review and discussion
among Credit, Portfolio Risk Review, lending officers, collection associates,
and senior management. Factors considered include the market value of collateral
or real estate associated with a specific loan or lease, cash flows generated by
the borrower, third-party guarantees, the general economic climate and any
specific industry trends that may affect an individual loan or lease.
Additional loss estimates associated with securitized assets and loans sold
under the Fannie Mae DUS Program are provided for separately from the reserve
for loan and lease losses. For more information on credit exposures on these
off-balance sheet assets, see "Management Discussion and Analysis of Financial
Condition and Results of Operations - Off-Balance Sheet and Derivative
Arrangements" and Note 20 of the "Notes to Consolidated Financial Statements."
Valuation of Securities: Securities are accounted for in accordance with
Statement No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." Provident classifies its securities as available for sale or
trading. Securities classified as available for sale are intended to be held for
indefinite periods of time. These securities are stated at fair value with
unrealized gains and losses (net of taxes) reported as a separate component of
shareholders' equity. Securities purchased with the intention of selling them in
the near term are classified as trading. These securities are
41
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
carried at fair value with unrealized gains and losses included in noninterest
income.
The fair value of securities are based on quoted market prices, where available.
If quoted market prices are not available, fair values are based on quoted
market prices of comparable instruments.
Included within securities available for sale are retained interest in
securitized assets. As quoted market prices are not available for RISAs,
Provident estimates the fair value based on key assumptions, including
prepayment speeds, credit losses, forward yield curves, and discount rates
commensurate with the risks involved.
Provident monitors the valuation of the RISAs on a monthly basis. The valuation
centers primarily around two estimates: total life-time credit losses and the
constant prepayment rate (CPR). During 2002 and 2003, both of these factors
trended upward which has had an unfavorable impact on the nonconforming
residential RISA valuation. Additionally, the CPR has also been impacted by
management's decision to accelerate the liquidation of other real estate
associated with the securitized nonconforming residential portfolio. Provident
models a CPR range from 30% to 36% with the actual trailing three-month CPR
currently running at 31.4%. If the CPR stays at its current level, management
estimates that there would be sufficient cash flows to absorb lifetime losses up
to 7.1%. If the CPR rises to 36%, there would be sufficient cash flows to absorb
lifetime losses up to 6.7%. Cumulative incurred losses through December 31, 2003
are 5.6%, with estimated total lifetime losses expected to be 6.5%. At December
31, 2003, management believes the current carrying value of the RISAs are
properly stated. Additional sensitivity analyses is provided in Note 3 of the
"Notes to Consolidated Financial Statements."
Valuation of Mortgage Servicing Rights: Provident recognizes the rights to
service mortgage loans it does not own but services for others within Other
Assets of its balance sheet. Mortgage servicing assets are carried at the lower
of the initial carrying value, adjusted for amortization, or estimated fair
value. Estimated fair value is based on projected discounted cash flows which
take into consideration estimated servicing fees, prepayment speeds, discount
rates, earnings on deposit of escrow funds and other assumptions. The mortgage
loan prepayment rate is the most significant factor driving the value of
mortgage servicing assets. Increases in mortgage loan prepayments reduce
estimated future servicing cash flows because the life of the underlying loan is
reduced. Mortgage servicing rights are tested quarterly to verify the market
value equals or exceeds its carrying value. During 2003, Provident recorded a
$1.8 million net impairment charge to its mortgage servicing assets. Impairment
charges result in an increase to the mortgage servicing valuation allowance.
Other-than-temporary impairment is recognized when the recoverability of a
recorded valuation allowance is determined to be remote, taking into
consideration historical and projected interest rates and loan payoff activity.
When this situation occurs, the unrecoverable portion of the valuation allowance
is applied as a direct write-down to the carrying value of mortgage servicing
assets. Unlike a valuation allowance, a direct write-down permanently reduces
the carrying value of mortgage servicing assets and the valuation allowance,
precluding subsequent recoveries. During 2003,
42
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Provident incurred $0.3 million in other-than-temporary impairment. Additional
information on mortgage servicing assets is provided in Note 9 of the "Notes to
Consolidated Financial Statements."
Valuation of Derivative Financial Instruments: Derivative Financial Instruments
are accounted for using the provisions of Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities." Statement 133 requires that
derivatives be recognized as either assets or liabilities in the balance sheet
and that those instruments be measured at fair value. The accounting for the
gain or loss resulting from the change in fair value depends on the intended use
of the derivative. For a derivative used to hedge changes in fair value of a
recognized asset or liability, or an unrecognized firm commitment, the gain or
loss on the derivative will be recognized in earnings together with the
offsetting loss or gain on the hedged item. This results in earnings recognition
only to the extent that the hedge is ineffective in achieving offsetting changes
in fair value. For a derivative used to hedge changes in cash flows associated
with forecasted transactions, the gain or loss on the effective portion of the
derivative will be deferred, and reported as accumulated other comprehensive
income, a component of shareholders' equity, until such time the hedged
transaction affects earnings. For derivative instruments not accounted for as
hedges, changes in fair value are required to be recognized in earnings. Note 19
of the "Notes to Consolidated Financial Statements" provides additional detail
on the accounting for financial derivative instruments and hedging activities.
The valuation of the financial derivative instruments is based on third-party
valuations. These valuations use discounted cash flow modeling techniques, which
require the use of assumptions concerning the amount and timing of future cash
flows. These estimates have a significant impact on the valuation of the
derivatives.
43
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The responsibility of monitoring and managing market and liquidity risk is
assigned to the Asset Liability Committee (ALCO). The main component of market
risk is the risk of loss in the value of financial instruments that may result
from the changes in interest rates. ALCO is bound to guidelines stated in the
relevant policies approved by the Board of Directors.
In addition to the natural balance sheet hedges, ALCO utilizes derivative
instruments to manage interest rate risk on and off its balance sheet. Interest
rate swaps and caps are the most widely used tools to manage interest rate risk.
Provident uses an earnings simulation model to analyze net interest income
sensitivity to movements in interest rates. The model evaluates the effect of
changes in interest rates on net interest income by running various interest
rate scenarios up and down from a flat rate scenario. As a basis for strategic
interest rate risk management, the ALCO group periodically analyzes the impact
of additional interest rate scenarios on net interest income in addition to the
standard scenarios used for policy measurement. These rate scenarios are
established by ALCO and incorporate changes to the slope of the yield curve. The
balance sheet assumptions, including loan growth, funding mix, and prepayment
speeds primarily on mortgage related products, are adjusted for each rate
scenario. Market-based prepayment speeds are incorporated into the analysis,
particularly for mortgage related products, including investment portfolio
securities. Faster prepayments during low interest rate environments such as the
current levels negatively impact interest rate margins due to lower reinvestment
yields.
Provident's policy limit stipulates that the negative impact on net interest
income from a +/-200 basis points, 12 month gradual parallel ramp rate scenario
as compared to the flat rate scenario cannot exceed 10 percent over the next 12
month period. These tests are performed on a monthly basis, and the results are
presented to the Board of Directors. Based on the results of the simulation
model, net interest income would change by the following over the next 12-month
period:
2003 2002
----- -------
100 Basis Points Decrease (3.74%) (3.92%)
100 Basis Points Increase 0.54% 0.55%
200 Basis Points Decrease n/a n/a
200 Basis Points Increase 0.03% (0.52%)
Due to the current low interest rate environment, nothing beyond a 100 basis
point decrease was simulated.
Although primarily classified as leased equipment, Provident continues to
include all of its auto leases in its interest sensitivity analysis.
ALCO regularly incorporates discussions and analyses of market risk embedded in
off-balance sheet activities as well as on non-interest income items such as
loan sale premiums. ALCO actively monitors the impact of related market risk
since these premiums are sensitive to changes in interest rates.
44
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
All transaction accounts are regularly analyzed for embedded market risk. These
accounts are evaluated with respect to their repricing characteristics as well
as their expected average lives. ALCO actively monitors the behavioral
characteristics of these products. Managed account rates adjust slower and at
smaller increments than short-term rates due to the competitive environment.
During the current low rate environment, such price rigidities negatively impact
interest rate margins in the short run; however, the long-term profitability and
liquidity characteristics of these accounts are very attractive.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
Report of Ernst & Young LLP, Independent Auditors ............ 46
Financial Statements:
Provident Financial Group, Inc. and Subsidiaries
Consolidated Balance Sheets .............................. 47
Consolidated Statements of Income ........................ 48
Consolidated Statements of Changes in Shareholders' Equity 49
Consolidated Statements of Cash Flows .................... 50
Notes to Consolidated Financial Statements ............... 51
Supplementary Data:
Quarterly Consolidated Results of Operations (unaudited) ..... 92
45
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors and Shareholders
Provident Financial Group, Inc.
We have audited the accompanying consolidated balance sheets of Provident
Financial Group, Inc. and subsidiaries as of December 31, 2003 and 2002, and the
related consolidated statements of income, changes in shareholders' equity and
cash flows for each of the three years in the period ended December 31, 2003.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Provident Financial Group, Inc. and subsidiaries at December 31, 2003 and 2002,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 2003, in conformity with
accounting principles generally accepted in the United States.
As discussed in Note 3 to the consolidated financial statements, on December 31,
2003, Provident Financial Group, Inc. changed its method of consolidation in
accordance with FASB Interpretation No. 46, "Consolidation of Variable Interest
Entities." Also, as discussed in Note 8 to the consolidated financial
statements, in 2002 Provident Financial Group, Inc. changed its method of
accounting for goodwill in accordance with Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets."
/s/ ERNST & YOUNG LLP
Cincinnati, Ohio
January 17, 2004
Except for Note 24, as to which the date is
February 17, 2004
46
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
-----------------------------
(Dollars in Thousands) 2003 2002
- ------------------------------------------------------ ------------ ------------
ASSETS
Cash and Due from Banks $ 273,299 $ 351,994
Federal Funds Sold and Reverse Repurchase Agreements 253,273 188,925
Trading Account Securities 119,646 127,848
Loans and Leases Held for Sale 595,505 436,884
Investment Securities Available for Sale
(amortized cost - $4,574,477 and $4,158,511) 4,527,912 4,215,238
Loans and Leases:
Corporate Lending:
Commercial 4,038,545 4,482,373
Mortgage 961,939 960,636
Construction 452,581 510,331
Lease Financing 1,275,255 1,273,901
Consumer Lending:
Installment 1,670,667 1,306,761
Residential 36,241 599,793
Lease Financing 460,302 -
------------ ------------
Total Loans and Leases 8,895,530 9,133,795
Reserve for Loan and Lease Losses (160,000) (201,051)
------------ ------------
Net Loans and Leases 8,735,530 8,932,744
Leased Equipment 1,653,264 2,350,356
Premises and Equipment 92,837 101,513
Goodwill 81,801 82,651
Other Assets 684,438 751,856
------------ ------------
TOTAL ASSETS $ 17,017,505 $ 17,540,009
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits:
Noninterest Bearing $ 1,491,473 $ 1,141,990
Interest Bearing 8,844,245 8,706,989
------------ ------------
Total Deposits 10,335,718 9,848,979
Short-Term Debt 1,443,438 1,925,005
Long-Term Debt 3,298,930 3,842,657
Junior Subordinated Debentures 465,799 -
Guaranteed Preferred Beneficial Interests in
Company's Junior Subordinated Debentures - 451,074
Minority Interest 160,966 160,966
Accrued Interest and Other Liabilities 413,600 430,957
------------ ------------
Total Liabilities 16,118,451 16,659,638
Shareholders' Equity:
Preferred Stock, 5,000,000 Shares Authorized:
Series D, 70,272 Issued 7,000 7,000
Common Stock, No Par Value, 110,000,000 Shares
Authorized, 49,039,997 and 48,760,462 Issued 14,538 14,454
Capital Surplus 305,632 298,025
Retained Earnings 652,206 604,013
Accumulated Other Comprehensive Loss (80,322) (43,121)
------------ ------------
Total Shareholders' Equity 899,054 880,371
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 17,017,505 $ 17,540,009
============ ============
See notes to consolidated financial statements.
47
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31,
------------------------------------
(In Thousands, Except Per Share Data) 2003 2002 2001
- --------------------------------------------- --------- --------- ---------
Interest Income:
Interest and Fees on Loans and Leases $ 535,158 $ 600,460 $ 747,930
Interest on Investment Securities 186,427 217,595 204,304
Other Interest Income 35,973 23,333 21,061
--------- --------- ---------
Total Interest Income 757,558 841,388 973,295
Interest Expense:
Interest on Deposits:
Savings and Demand Deposits 42,140 38,748 68,559
Time Deposits 173,501 223,424 317,810
--------- --------- ---------
Total Interest on Deposits 215,641 262,172 386,369
Interest on Short-Term Debt 31,231 35,642 55,819
Interest on Long-Term Debt 176,642 204,742 230,061
Interest on Junior Subordinated Debentures 18,252 23,274 30,551
--------- --------- ---------
Total Interest Expense 441,766 525,830 702,800
--------- --------- ---------
Net Interest Income 315,792 315,558 270,495
Provision for Loan and Lease Losses 115,979 99,549 215,545
--------- --------- ---------
Net Interest Income After Provision for
Loan and Lease Losses 199,813 216,009 54,950
Noninterest Income:
Service Charges on Deposit Accounts 50,023 45,184 39,924
Loan Servicing Fees 40,163 36,980 34,469
Commercial Mortgage Banking Revenue 44,791 25,354 29,490
Other Service Charges and Fees 50,935 45,418 37,390
Leasing Income 510,109 605,887 584,065
Cash Gain on Sales of Loans and Leases 20,333 15,691 6,311
Warrant Gains 1,636 8,186 412
Net Security Gains 6,307 2,596 -
Net Gain on Florida Assets and Liabilities 74,998 - -
Net Gain on Merchant Services Business 19,000 - -
Other 26,994 20,196 24,375
--------- --------- ---------
Total Noninterest Income 845,289 805,492 756,436
Noninterest Expense:
Salaries, Wages and Benefits 253,399 233,178 201,715
Charges and Fees 32,152 30,531 31,888
Occupancy 25,365 23,637 22,605
Leasing Expense 365,408 416,508 402,372
Equipment Expense 26,285 24,345 25,234
Professional Fees 32,667 25,990 24,507
Minority Interest Expense 12,788 7,069 -
Debt Retirement Charge 25,584 - -
Disposition Cost of Subprime Loans 6,914 - -
Other 119,493 114,770 104,663
--------- --------- ---------
Total Noninterest Expenses 900,055 876,028 812,984
--------- --------- ---------
Income (Loss) Before Income Taxes and
Cumulative Effect of Changes in
Accounting Principles 145,047 145,473 (1,598)
Applicable Income Taxes 47,145 50,022 (595)
--------- --------- ---------
Income (Loss) Before Cumulative Effect
of Changes in Accounting Principles 97,902 95,451 (1,003)
Cumulative Effect of Changes in
Accounting Principles (1,202) - -
--------- --------- ---------
Net Income (Loss) $ 96,700 $ 95,451 $ (1,003)
========= ========= =========
Before Cumulative Effect of Changes in
Accounting Principles:
Basic Earnings (Loss) Per Common Share $ 1.99 $ 1.94 $ (.04)
Diluted Earnings (Loss) Per Common Share 1.92 1.88 (.04)
After Cumulative Effect of Changes in
Accounting Principles:
Basic Earnings (Loss) Per Common Share $ 1.96 $ 1.94 $ (.04)
Diluted Earnings (Loss) Per Common Share 1.90 1.88 (.04)
Cash Dividends Paid Per Common Share .96 .96 .96
See notes to consolidated financial statements.
48
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Accumulated
Common Other
(In Thousands, Preferred --------------------- Capital Retained Comprehensive
Except Per Share Data) Stock Shares Stock Surplus Earnings Loss, Net Total
- ------------------------------- --------- -------- ---------- ------------ ------------ ------------- -----------
Balance at January 1, 2001 7,000 48,814 14,469 314,895 605,923 (17,929) 924,358
Net Loss (1,003) (1,003)
Other Comprehensive
Income, Net of Tax:
Cumulative Effect of a Change
in Accounting Principle (28,332) (28,332)
Change in Unrealized
Gains (Losses) on:
Hedging Instruments (54,411) (54,411)
Marketable Securities 1,976 1,976
-----------
Total Comprehensive Loss (81,770)
Cash Dividends Declared on:
Common Stock ($.96/share) (47,053) (47,053)
Preferred Stock ($13.50/share) (949) (949)
Exercise of Stock Options and
Accompanying Tax Benefits 375 113 6,477 6,590
Distribution of Contingent
Shares for Prior Year
Acquisition 28 8 822 830
Stock Purchased and Cancelled (11) (3) (243) (246)
Other 73 73
--------- -------- ---------- ------------ ------------ ------------ -----------
Balance at December 31, 2001 7,000 49,206 14,587 322,024 556,918 (98,696) 801,833
Net Income 95,451 95,451
Other Comprehensive
Income, Net of Tax:
Change in Unrealized
Gains (Losses) on:
Hedging Instruments 2,813 2,813
Marketable Securities 52,762 52,762
-----------
Total Comprehensive Income 151,026
Cash Dividends Declared on:
Common Stock ($.96/share) (47,385) (47,385)
Preferred Stock ($13.50/share) (949) (949)
Exercise of Stock Options and
Accompanying Tax Benefits 336 101 5,200 5,301
Benefit Plan Assets in
Provident Stock (781) (234) (22,258) (22) (22,514)
Costs and Present Value of
Contract Payments of
PRIDES Securities (6,917) (6,917)
Stock Purchased and Cancelled (1) (24) (24)
--------- -------- ---------- ------------ ------------ ------------ -----------
Balance at December 31, 2002 $ 7,000 48,760 $ 14,454 $ 298,025 $ 604,013 $ (43,121) $ 880,371
Net Income 96,700 96,700
Other Comprehensive
Income, Net of Tax:
Change in Unrealized
Gains (Losses) on:
Hedging Instruments 29,824 29,824
Marketable Securities (67,025) (67,025)
-----------
Total Comprehensive Income 59,499
Cash Dividends Declared on:
Common Stock ($.96/share) (47,554) (47,554)
Preferred Stock ($13.50/share) (949) (949)
Exercise of Stock Options and
Accompanying Tax Benefits 336 101 7,831 7,932
Benefit Plan Assets in
Provident Stock (56) (17) (1,267) (4) (1,288)
Expensing of Stock Options,
Net of Tax 1,043 1,043
--------- -------- ---------- ------------ ------------ ------------ -----------
Balance at December 31, 2003 $ 7,000 49,040 $ 14,538 $ 305,632 $ 652,206 $ (80,322) $ 899,054
========= ======== ========== ============ ============ ============ ===========
See notes to consolidated financial statements.
49
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
-------------------------------------------
(In Thousands) 2003 2002 2001
- ------------------------------------------------------ ----------- ----------- -----------
Operating Activities:
Net Income (Loss) $ 96,700 $ 95,451 $ (1,003)
Adjustments to Reconcile Net Income to Net Cash
Provided by (Used in) Operating Activities:
Provision for Loan and Lease Losses 115,979 99,549 215,545
Other Amortization and Accretion 71,101 26,654 4,400
Depreciation of Leased Equipment 366,731 419,438 387,235
Depreciation of Premises and Equipment 23,764 22,088 22,482
Impairment Charge on Mortgage Servicing Assets 1,844 539 -
Tax Benefit Received from Exercise of Stock Options 1,570 1,069 2,706
Expensing of Stock Option Grants 1,259 - -
Gain on Sale of Florida Assets and Liabilities (74,998) - -
Gain on Sale of Merchant Services (19,000) - -
Realized Investment Security Gains (6,307) (2,596) -
Proceeds From Sale of Loans Held for Sale 4,464,905 3,065,139 2,825,184
Origination of Loans Held for Sale (4,610,822) (3,270,407) (2,834,074)
Realized Gains on Loans Held for Sale (12,704) (13,702) (2,856)
(Increase) Decrease in Trading Account Securities 8,202 (11,368) (59,207)
(Increase) Decrease in Interest Receivable (22,389) 1,171 4,402
Increase in Other Assets (13,514) (6,250) (144,760)
Decrease in Interest Payable (5,886) (4,745) (4,099)
Increase (Decrease) in Deferred Income Taxes 53,316 22,550 (12,249)
Increase (Decrease) in Other Liabilities (71,048) (62,728) 57,930
----------- ----------- -----------
Net Cash Provided by Operating Activities 368,703 381,852 461,636
----------- ----------- -----------
Investing Activities:
Investment Securities Available for Sale:
Proceeds from Sales 3,018,207 1,423,825 2,264,759
Proceeds from Maturities and Prepayments 1,794,394 1,282,271 1,120,965
Purchases (5,087,300) (3,347,912) (3,367,243)
Net Increase in Loans and Leases (288,422) (320,208) (1,085,819)
Net (Increase) Decrease in Leased Equipment 330,361 (118,400) (652,695)
Net Increase in Premises and Equipment (21,657) (20,516) (21,648)
Net Cash Paid in Sale of Florida Operations
and Merchant Services (410,287) - -
----------- ----------- -----------
Net Cash Used in Investing Activities (664,704) (1,100,940) (1,741,681)
----------- ----------- -----------
Financing Activities:
Net Increase in Deposits 1,436,516 882,968 43,254
Net Increase (Decrease) in Short-Term Debt (481,567) 39,696 1,246,286
Principal Payments on Long-Term Debt (631,154) (366,959) (259,041)
Proceeds from Issuance of Long-Term Debt and
Junior Subordinated Debentures - 86,239 426,032
Proceeds from Issuance of Minority Interest - 160,966 -
Cash Dividends Paid (48,503) (48,334) (48,002)
Repurchase of Common Stock - (24) (246)
Proceeds from Exercise of Stock Options 6,362 4,232 3,884
Net Increase in Other Equity Items - - 73
----------- ----------- -----------
Net Cash Provided by Financing Activities 281,654 758,784 1,412,240
----------- ----------- -----------
Increase (Decrease) in Cash and Cash Equivalents (14,347) 39,696 132,195
Cash and Cash Equivalents at Beginning of Period 540,919 501,223 369,028
----------- ----------- -----------
Cash and Cash Equivalents at End of Period $ 526,572 $ 540,919 $ 501,223
=========== =========== ===========
Supplemental Disclosures of Cash Flow Information:
Cash Paid for:
Interest $ 447,652 $ 464,821 $ 634,239
Income Taxes 2,786 6,318 20,044
Non-Cash Activity:
Transfer of Loans and Premises and Equipment
to Other Real Estate 20,071 23,680 22,444
See notes to consolidated financial statements.
50
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ACCOUNTING POLICIES: The following is a summary of significant
accounting policies:
NATURE OF OPERATIONS: Provident Financial Group, Inc. (Provident) is a bank
holding company headquartered in Cincinnati, Ohio. Provident operates bank and
other financial service subsidiaries principally in Ohio and northern Kentucky.
Principal products and services provided by Provident include commercial
lending, lease financing, cash management, retail lending, deposit accounts,
mortgage banking, brokerage services, investment products and trust services.
BASIS OF PRESENTATION: The accounting and reporting policies of Provident
conform with accounting principles generally accepted in the United States.
Certain estimates are required to be made by management in the preparation of
the consolidated financial statements. Actual results may differ from those
estimates. The consolidated financial statements include the accounts of
Provident and its subsidiaries. All significant intercompany balances and
transactions have been eliminated. Certain reclassifications have been made to
conform to the current year presentation.
Special purpose entities (SPEs) have been formed for many of Provident's
securitization transactions. These SPEs are not operating entities, have no
employees, and have a limited life. The basic SPE structure involves Provident
transferring loans or leases to the SPE. The SPE funds the purchase of these
assets by issuing debt securities to investors. The legal documents governing
the SPE transactions describe how the cash earned on the assets held in the SPE
must be allocated to the investors and other parties that have rights to these
cash flows. SPEs can be structured to be bankruptcy remote, thereby insulating
investors from the impact of the creditors of other entities, including the
seller of the assets. SPEs are critical to the functioning of several
significant markets, including the asset-backed securities, mortgage-backed
securities and commercial paper.
Generally, Provident's securitization transactions from 1997 through the second
quarter of 2000 involved loans and equipment leases being transferred to SPEs.
These transactions meet the applicable qualifying special-purpose entity (QSPE)
criteria under Statement No. 140 "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," and are not consolidated
on Provident's balance sheet.
Provident also sold nonconforming residential loans through securitizations
during 1996. As these transactions occurred prior to the issuance of Statement
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," the SPEs formed in these transactions do not
meet the definition of a QSPE and are now consolidated in Provident's financial
statements as of December 31, 2003. Additional details regarding these
securitization trusts are provided in Note 3.
STATEMENTS OF CASH FLOWS: For cash flow purposes, cash equivalents include
amounts due from banks and federal funds sold and reverse repurchase agreements.
Generally, federal funds sold and reverse repurchase agreements are purchased
and sold for one-day periods.
REVERSE REPURCHASE AGREEMENTS AND REPURCHASE AGREEMENTS: Securities purchased
under agreements to resell (reverse repurchase agreements) and securities sold
under agreements to repurchase (repurchase agreements) are treated as
51
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
collateralized financing transactions and are recorded at the amounts at which
the securities were acquired or sold plus accrued interest. Securities,
generally U.S. government, federal agency and agency mortgage-backed securities,
pledged as collateral under these financing arrangements cannot be sold or
repledged by the secured party. The fair value of collateral either received
from or provided to a third party is continually monitored by Provident.
SECURITIES: Securities are classified as available for sale or trading.
Securities classified as available for sale are intended to be held for
indefinite periods of time. These securities are stated at fair value with
unrealized gains and losses (net of taxes) reported within Accumulated Other
Comprehensive Loss of shareholders' equity.
Securities purchased with the intention of selling them in the near term are
classified as trading. These securities are carried at fair value with
unrealized gains and losses included in noninterest income. The specific
identification method is used for determining gains and losses from securities
transactions.
LOANS AND LEASES: Loans are generally stated at the principal amount
outstanding. Loans that are intended to be sold within a short period of time
are classified as held for sale. Loans held for sale are reported at the lower
of aggregate cost or market value. Interest on loans is computed on the
outstanding principal balance. The portion of loan fees which exceeds the direct
costs to originate the loan is deferred and recognized as interest income over
the estimated lives of the related loans using the interest method. Loan
commitment fees are generally deferred and amortized into interest income on a
straight-line basis over the commitment period. Any premium or discount
applicable to specific loans purchased is amortized over the remaining lives of
such loans using the interest method. Loans are generally placed on nonaccrual
status when the payment of principal or interest is past due 90 days or more.
However, installment loans are not placed on nonaccrual status because they are
charged off in the month the loans reach 120 days past due. In addition, loans
that are well secured and in the process of collection are not placed on
nonaccrual status. When a loan is placed on nonaccrual status, any interest
income previously recognized that has not been received is reversed. Future
interest income is recorded only when a payment is received and collection of
principal is considered reasonably assured. Income on impaired loans is
generally recognized on a cash basis.
Leases are classified as either direct financing leases or operating leases,
based on the terms of the lease arrangement. To be classified as a direct
financing lease, the lease must have at least one of the following four
characteristics: (1) the lease transfers ownership of the property to the lessee
by the end of the lease term; (2) the lease contains a bargain purchase option;
(3) the lease term is equal to 75% or more of the estimated economic life of the
leased property; or (4) the present value of the lease payments and the
guaranteed residual value are at least 90% of the cost of the leased property.
Leases that do not meet any of these four criteria are classified as Leased
Equipment. The accounting policies for these financial instruments are discussed
later in this Note.
An important factor in determining the classification of Provident's auto lease
portfolio is the form of its residual value insurance. From 1994 to January
2003, Provident obtained residual value insurance for its auto leases
52
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
on a pool basis by year of origination. The insurance is commonly referred to as
"capped" insurance. This type of insurance coverage, while effective in removing
residual risk, does not result in direct financing lease classification for its
auto leases. As residual value insurance for auto leases originated in February
2003 and later does not have this capped feature, but rather provides lease by
lease coverage, these auto leases are accounted for as direct financing leases.
When a lease is classified as a direct financing lease, the sum of the aggregate
rentals receivable and the estimated residual value of leased equipment less
unearned income and third party debt on leveraged leases are recorded as an
asset under Loans and Leases. Unearned income on direct financing leases is
amortized over the terms of the leases resulting in an approximate level rate of
return on the net investment in the leases. Income from leveraged lease
transactions is recognized using a method that yields a level rate of return in
relation to Provident's net investment in the lease. Commercial leases are
generally placed on nonaccrual status when payments are past due 90 days or more
while consumer leases are generally charged off in the month the leases reach
120 days past due.
Residual values on commercial lease assets are reviewed regularly for
impairment. When impairment exists, the carrying value of the residual is
reduced to the estimated fair value with the write-down recorded as a reduction
to the reserve for loan and lease losses. Regarding consumer leases, Provident's
residual value insurance covers the difference between the residual value and
the market value of the automobile at the end of the lease term. The market
value is determined as the greater of the proceeds received from the sale of the
automobile or the Black Book Used Car Market Guide Monthly valuations. This
insurance, however, does not cover residual losses when the automobile may be
sold for below Black Book Used Car Market Guide Monthly value, which may arise
when the automobile has excess wear and tear and/or excess mileage, not
reimbursed by the lessee.
RESERVE FOR LOAN AND LEASE LOSSES: The reserve for loan and lease losses is
maintained at a level that management estimates as necessary to absorb losses
inherent in the lending portfolio. The reserve is increased by charges to
earnings, as provisions for loan and lease losses. Loans and leases are charged
off when deemed uncollectible and deducted from the reserve, while recoveries of
previous charge-offs are added back to the reserve.
Management's determination of the adequacy of the reserve is based on an
assessment of the inherent loss potential given the conditions at the time.
Loans and leases reviewed on an individual basis include large non-homogeneous
credits and higher risk loans where the internal credit rating is at or below a
predetermined classification.
Corporate loans and leases not individually reviewed are segmented by the
characteristics related to the reserve factors. Corporate loan and lease reserve
factors are based upon quantitative migration analysis resulting in estimated
default frequencies and loss in the event of default parameters. These factor
estimates are reviewed and updated to reflect actual experience as needed.
Provident considers a corporate loan to be an impaired loan when it is probable
that all amounts due will not be collected according to the contractual terms of
the loan agreement. Provident measures the value of an impaired loan based on
the present value of expected future cash flows
53
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
discounted at the loan's effective interest rate or, if more practical, at the
loan's observable market price, or the fair value of the collateral if the loan
is collateral dependent. These value estimates result in specific reserve
allocations.
Consumer loans are segmented by retail product. Forecast models for the consumer
products are generally based on recent delinquency trends, credit score and
loan-to-value distributions, and static pool analysis, or a combination of the
three.
LOAN AND LEASE SECURITIZATIONS: Provident has securitized loans and leases in
accordance with the provisions of Statement 140. Loans and leases securitized by
Provident include nonconforming residential loans, equipment leases and home
equity loans and lines of credit. Securitizations have provided Provident with
immediate cash flows to fund additional loan and lease originations and
purchases. Prior to June 30, 2000, Provident's securitizations were generally
treated as sales, resulting in the removal of the loans and leases from the
balance sheet and the recognition of gains or losses on the income statement.
Since June 30, 2000, Provident's securitizations have been treated as secured
financings, resulting in additional debt on the balance sheet and no recognition
of gains or losses on the income statement. The change to a secured financing
structure does not affect the total profit Provident will recognize over the
life of a loan, but rather impacts the timing of income recognition. Secured
financing transactions, on a comparative basis, cause reported earnings from
securitized loans to be lower in the initial periods and higher in later
periods, as interest is earned on the loans.
In a mortgage related securitization, Provident transfers a pool of loans to a
trust. The trust funds the purchase of these assets by issuing debt securities
to investors. The legal documents governing the trust describe how the cash
earned on the assets held in the trust must be allocated to the investors and
other parties that have rights to these cash flows. Generally, Provident's
current value of these estimated excess cash flows include future cash flows of
the underlying loans, net of payments due to investors of the securitization
trust, credit losses, servicing fees and other fees (referred to as retained
interest in securitized assets or RISAs), and servicing rights on the loans.
Gain or loss on the sale of the loans, which was recorded in noninterest income,
depended in portion on the previous carrying amount of the financial assets
involved in the transfer, allocated between the assets sold and the assets
retained based on their relative fair value at the date of transfer.
As the RISAs are classified as available for sale investment securities, the
assets are stated at fair value with unrealized gains and losses (net of taxes)
reported within shareholders' equity. Fair value is based on management's best
estimates of the valuation assumptions, including credit losses, prepayment
speeds, forward yield curves, and discount rates commensurate with the risks
involved.
LEASED EQUIPMENT: Leases that do not qualify for direct finance lease treatment
are accounted for as operating leases and are classified as leased equipment on
the balance sheet. Rental income for leased equipment is recognized on a
straight-line basis as scheduled. Related depreciation expense is recorded on
the straight-line basis over the life of the lease based upon the estimated
residual value. On a periodic basis, a review is undertaken to determine if the
leased equipment is impaired. An impairment
54
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
loss is recognized if the carrying amount of the leased equipment is not
recoverable and exceeds its fair value. The carrying amount of the leased
equipment is not recoverable if it exceeds the sum of the undiscounted cash
flows expected to result from the lease payments and the eventual disposition of
the assets. Auto lease receivables are written off in the month the leases reach
120 days past due while equipment leases are written off when deemed
uncollectible.
PREMISES AND EQUIPMENT: Premises and equipment are stated at cost less
depreciation and amortization that are computed principally on the straight-line
method over the estimated useful lives of the assets.
GOODWILL: Goodwill is the excess of the purchase price over net identifiable
tangible and intangible assets acquired in a purchase business combination.
Provident adopted the provisions of Statement No. 141, "Business Combinations,"
and No. 142, "Goodwill and Other Intangible Assets," on January 1, 2002. Under
the new rules, goodwill and intangible assets deemed to have indefinite lives
will no longer be amortized but will be subject to annual impairment tests in
accordance with the Statements. Other intangible assets determined to have
limited lives continue to be amortized over their useful lives.
MORTGAGE SERVICING ASSETS: Provident recognizes the rights to service mortgage
loans it does not own but services for others within Other Assets of its balance
sheet. Mortgage servicing assets may be recognized (1) when mortgage loans are
sold with servicing retained or (2) when mortgage loan servicing is purchased.
When mortgage loans are sold, the carrying value of the loans is allocated
between the loans sold and servicing assets retained based on the relative fair
values of each. Mortgage servicing assets, when purchased, are initially
recorded at cost. Mortgage servicing assets are carried at the lower of the
initial carrying value, adjusted for amortization, or estimated fair value.
Estimated fair value is based on projected discounted cash flows which takes
into consideration estimated servicing fees, prepayment speeds, discount rates,
earnings on deposit of escrow funds and other assumptions. Mortgage servicing
assets are tested quarterly to verify the market value equals or exceeds its
carrying value. Impairment charges result in an increase to the mortgage
servicing valuation allowance and an offsetting charge against loan servicing
fees.
Other-than-temporary impairment is recognized when the recoverability of a
recorded valuation allowance is determined to be remote taking into
consideration historical and projected interest rates and loan payoff activity.
When this situation occurs, the unrecoverable portion of the valuation allowance
is applied as a direct write-down to the carrying value of mortgage servicing
assets. Unlike a valuation allowance, a direct write-down permanently reduces
the carrying value of mortgage servicing assets and the valuation allowance,
precluding subsequent recoveries.
EQUITY INVESTMENTS: Provident invests in affordable housing partnerships, equity
funds and directly in equity securities, which are collectively referred to
herein as equity investments. Equity investments, which are reported within
Investment Securities Available for Sale and Other Assets, are carried at
estimated fair value with changes in fair value recognized in other noninterest
income. The fair value of publicly traded investments are determined using
quoted market prices less liquidity discounts. Liquidity discounts take into
account the fact that Provident may not immediately realize such market prices
due to regulatory, corporate and contractual sales
55
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
restrictions. The estimated fair value of equity investments that are not
publicly traded approximates cost including other than temporary valuation
adjustments considered appropriate by management. As of December 31, 2003 and
2002, Provident held equity investments with a carrying value of $60.2 million
and $72.1 million, respectively.
OTHER REAL ESTATE AND EQUIPMENT: Other real estate and equipment acquired
through partial or total satisfaction of loans is recorded at the lower of cost
or fair value and is included in Other Assets of the consolidated balance sheet.
Provident's policy is to include the unpaid balance of applicable loans in the
cost of other real estate and equipment. However, in no case is the carrying
value of other real estate and equipment greater than fair value. At December
31, 2003 and 2002, the carrying value of other real estate and equipment owned
was $4.3 million and $15.8 million, respectively.
STOCK-BASED COMPENSATION: Statement No. 123, "Accounting for Stock-Based
Compensation" encourages, but does not require, adoption of a fair value-based
accounting method for stock-based employee compensation plans. Provident adopted
the provisions of Statement 123 as of January 1, 2003. Under these rules,
compensation expense is recognized over the vesting period equal to the fair
value of stock-based compensation as of the date of grant. As Provident has
elected to use the Prospective Method of expense recognition according to the
transition rules of Statement No. 148, "Accounting for Stock-Based Compensation
- - Transition and Disclosure," the adoption of Statement 123 applies only to
options granted after December 31, 2002. Prior to January 1, 2003, Provident
accounted for stock-based employee compensation plans in accordance with
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees," whereby no compensation expense is recognized for the granting of
stock options when the exercise price of the option equals the market price of
the underlying stock at date of grant.
For purposes of providing pro forma disclosures as if Statement 123 had been
adopted as of its effective date (grants issued in fiscal years that begin after
December 15, 1994), the fair value of stock options was estimated at the date of
grant using a Black-Scholes option pricing model. The Black-Scholes option
pricing model was developed for use in estimating the fair value of traded
options that have no vesting restrictions and are fully transferable. In
addition, option valuation models require the input of subjective assumptions
including the expected stock price volatility.
The following weighted-average assumptions were used in the option pricing model
for 2003, 2002 and 2001 respectively: risk-free interest rates of 3.46%, 4.50%
and 4.72%; dividend yields of 3.50%, 3.50% and 3.00%; volatility factors of the
expected market price of Provident's Common Stock of 29.2%, 29.1% and 28.8% and
an expected life of the option of 7 years for each year. Based on these
assumptions, the weighted-average fair value of options granted in 2003, 2002
and 2001 was $6.45, $5.89 and $8.35, respectively.
56
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Provident recorded $1.3 million ($1.0 million after-tax) of stock-based
compensation for 2003 while no compensation cost was recognized for stock option
grants during 2002 and 2001. Had compensation cost been expensed for stock
option awards based on the fair values at grant dates as discussed above,
Provident's net income and earnings per share would have been as follows:
Year Ended December 31,
----------------------------------------------
(In Thousands, Except Per Share Data) 2003 2002 2001
- ----------------------------------------------- ------------ ------------ ------------
Net Income as Reported $ 96,700 $ 95,451 $ (1,003)
Plus Stock-Based Compensation Recognized for
Options Granted in 2003, Net of Related Tax 1,043 - -
Less Total Stock-Based Compensation Determined
under Fair Value Based Methods, Net of Related
Tax Effects (6,965) (9,662) (7,181)
------------ ------------ ------------
Pro-forma Net Income $ 90,778 $ 85,789 $ (8,184)
============ ============ ============
Earnings Per Share:
Basic - As Reported $ 1.96 $ 1.94 $ (0.04)
Basic - Pro Forma 1.84 1.74 (0.19)
Diluted - As Reported 1.90 1.88 (0.04)
Diluted - Pro Forma 1.81 1.72 (0.19)
INCOME TAXES: Provident files a consolidated federal income tax return that
includes all of its subsidiaries. Subsidiaries provide for income taxes on a
separate-return basis and remit to Provident amounts determined to be currently
payable.
DERIVATIVE FINANCIAL INSTRUMENTS: Provident employs derivatives such as interest
rate swaps, caps and floors to manage the interest sensitivity of certain on and
off-balance sheet assets and liabilities. The net interest income or expense on
interest rate swaps and caps is accrued and recognized as an adjustment to the
interest income or expense of the associated on and off-balance sheet asset or
liability.
Provident adopted the provisions of Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended, on January 1, 2001.
Statement 133 requires that derivatives be recognized as either assets or
liabilities in the balance sheet and that those instruments be measured at fair
value. The accounting for the gain or loss resulting from the change in fair
value depends on the intended use of the derivative. For a derivative used to
hedge changes in fair value of a recognized asset or liability, or an
unrecognized firm commitment, the gain or loss on the derivative will be
recognized in earnings together with the offsetting loss or gain on the hedged
item. This results in earnings recognition only to the extent that the hedge is
ineffective in achieving offsetting changes in fair value. For a derivative used
to hedge changes in cash flows associated with forecasted transactions, the gain
or loss on the effective portion of the derivative will be deferred, and
reported as accumulated other comprehensive income, a component of shareholders'
equity, until such time the hedged transaction affects earnings. For derivative
instruments not accounted for as hedges, changes in fair value are required to
be recognized in earnings. Note 19 provides additional detail on the accounting
for derivative instruments and hedging activities held by Provident.
NOTE 2 - RECENT ACCOUNTING PRONOUNCEMENTS: In December 2002, Statement No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure" was
issued. Statement 148 amends Statement No. 123, "Accounting for Stock-Based
Compensation", to provide alternative methods of transition to Statement 123's
fair value based method of accounting for stock-based employee compensation.
Statement 148 also amends the disclosure provisions of Statement 123 and APB
Opinion No. 28, "Interim Financial Reporting," to require disclosure in the
summary of significant accounting policies of the effects of an entity's
accounting policy with respect to stock-based
57
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
employee compensation on reported net income and earnings per share in annual
and interim financial statements. While the Statement does not amend Statement
123 to require companies to account for employee stock options using the fair
value method, the disclosure provisions of Statement 148 are applicable to all
companies with stock-based employee compensation, regardless of whether they
account for that compensation using the fair value method of Statement 123 or
the intrinsic value method of APB Opinion No. 25. As discussed in Note 1,
Provident adopted the provisions of Statement 123 using the Prospective Method
of expense recognition according to Statement 148. Provident recorded $1.3
million ($1.0 million after-tax) of stock-based compensation for 2003 as of a
result of adopting Statement 123.
In April 2003, the FASB issued Statement No. 149 "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." Statement 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under Statement 133 "Accounting for Derivative Instruments
and Hedging Activities." Statement 149 amends Statement 133 for decisions made
(1) as part of the Derivatives Implementation Group process that effectively
required amendments to Statement 133, (2) in connection with other FASB projects
dealing with financial instruments, and (3) in connection with implementation
issues raised in relation to the application of the definition of a derivative.
Statement 149 is effective for contracts entered into or modified after June 30,
2003, and hedging relationships designated after June 30, 2003. However, the
provisions of Statement 149 that merely represent the codification of previous
Derivatives Implementation Group decisions were already effective and were
applied in accordance with their prior respective effective dates. The adoption
of this Statement did not have any significant impact on Provident's results of
operations or financial condition.
In May 2003, the FASB issued Statement 150 "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." Statement 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability. Many of those instruments were previously classified as equity.
Statement 150 is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise became effective as of July 1, 2003. The
adoption of this Statement did not have any significant impact on Provident's
results of operations or financial condition.
In December 2003, the FASB issued revised FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" (FIN 46R). FIN 46R, which is an
interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial
Statements," addresses consolidation by business enterprises of variable
interest entities (VIEs). A VIE exists when (1) the equity investment at risk is
not sufficient to permit the entity to finance its activities without additional
subordinated financial support; (2) equity investors do not have the ability to
make decisions about the entity's activities through voting rights or do not
have the obligation/right to absorb expected losses/residual returns of the
entity; or (3) equity investors have voting rights that are not proportionate to
their economic
58
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
interests and the activities of the entity are conducted on behalf of an
investor with a disproportionately small voting interest. FIN 46R requires VIEs
to be consolidated by their primary beneficiaries. The primary beneficiary of a
VIE is the party that absorbs a majority of the entity's expected losses and/or
receives a majority of its expected residual returns as a result of holding
variable interests. FIN 46R becomes effective for entities that have interest in
special purpose entities (SPEs) for periods ending after December 15, 2003, and
for all other types of VIEs for periods ending after March 15, 2004. As of
December 31, 2003, Provident adopted the provisions of FIN 46R for SPEs. This
resulted in additional assets of $28.5 million and an after-tax charge to
earnings of $1.2 million. See Note 3 for further discussions of VIEs.
NOTE 3 - INVESTMENTS IN VARIABLE INTEREST ENTITIES: As discussed in Note 2, FASB
issued revised FASB Interpretation No. 46, "Consolidation of Variable Interest
Entities" (FIN 46R) in December 2003. As a result of FIN 46R, Provident
consolidated two securitization trusts (PCFS 96-1 and PCFS 96-2) and
de-consolidated four other trusts (Provident Capital Trust I, II, III and IV).
From 1996 to 2000, Provident securitized and sold loans and equipment leases
through the creation of securitization trusts (also referred to as special
purpose entities or SPEs). These securitization trusts are not operating
entities, have no employees, and have a limited life. The basic securitization
structure involves Provident transferring loans or leases to the securitization
trust. The securitization trust funds the purchase of these assets by issuing
debt securities to investors. The legal documents governing the securitization
trust transactions describe how the cash earned on the assets held in the SPE
must be allocated to the investors and other parties that have rights to these
cash flows. Securitization trusts can be structured to be bankruptcy remote,
thereby insulating investors from the impact of the creditors of other entities,
including the seller of the assets.
Provident accounted for these securitization transactions according to
Statements No. 125 and No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities." Under these Statements, a
transfer of financial assets in which the transferor surrenders control over
those assets is accounted for as a sale to the extent that consideration other
than beneficial interests in the transferred assets is received in exchange.
Accordingly, the loans and equipment leases sold to these securitization trusts
were removed from Provident's balance sheet and the securitization trusts were
not consolidated. Statement No. 140 provides specific criteria for determining
when an SPE meets the definition of a qualifying special-purpose entity (QSPE).
The securitization trusts, with the exception of PCFS 96-1 and PCFS 96-2, meet
the applicable QSPE criteria under Statement 140.
As loans were sold to the PCFS 96-1 and PCFS 96-2 securitization trusts prior to
the effective date of Statement No. 125, the securitization trusts do not meet
the definition of a QSPE and are now required to be consolidated in Provident's
financial statements as of December 31, 2003 based on the provisions of FIN 46R.
The consolidation of PCFS 96-1 and 96-2 securitization trusts resulted in an
additional $14.1 million in loans being recorded on Provident's balance sheet
and an after-tax cumulative effect of changes in accounting principles of $1.2
million being charged against earnings.
59
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Between 1996 and 2001, Provident formed Provident Capital Trust I, II, III and
IV, collectively referred to as Provident Capital Trusts. Provident Capital
Trusts issued a total of $462.5 million of preferred securities to outside
investors and $14.3 million of common securities to Provident. Proceeds from the
issuance of these capital securities were invested in Provident's Junior
Subordinated Debentures. Generally, the Junior Subordinated Debentures qualify
as Tier I capital for bank regulatory purposes.
FIN 46R states that an enterprise shall consolidate a variable interest entity
if that enterprise has a variable interest that will absorb a majority of the
entity's expected losses, receive a majority of the entity's expected residual
returns, or both. Provident will not absorb a majority of Provident Capital
Trusts expected losses or receive a majority of their expected residual returns.
As of December 31, 2003, Provident's consolidated financial statements no longer
include the Provident Capital Trusts entities.
As the capital securities of Provident Capital Trusts are mandatorily redeemable
upon the maturity of the Debentures, Provident had been reporting the preferred
securities of Provident Capital Trusts similar to long-term debt within its
financial statements. As a result of the de-consolidation, Provident recorded
its $14.3 million common stock investment in Provident Capital Trusts as equity
investments within Other Assets and as additional borrowings within Junior
Subordinated Debentures of its balance sheet, whereas in prior periods, this
common stock investment had been eliminated within consolidation. The
de-consolidation of Provident Capital Trusts had no impact on earnings.
Provident has evaluated the applicability of FIN 46R on other various
investments and interests, including affordable housing partnerships, equity
investments, small business commercial real estate partnerships, leverage
leasing structures, customer trust accounts and securitization trusts. It was
determined that certain of these investments and interests were variable
interest entities, however, as Provident was not the primary beneficiary, these
entities were not consolidated.
Provident's involvement with affordable housing partnerships has been from the
aspect of receiving investment tax credits as a limited partner and receiving
fees for forming investment partnerships as a general partner. Provident's
investment in affordable housing partnerships at December 31, 2003 was $18
million which is also Provident's maximum exposure to loss.
Provident has also acquired interest in other entities by purchasing limited
partner interests in equity funds and directly investing in other entities'
common and preferred stock. The objective for these investments may be either
strategic or non-strategic. Strategic investments are made to companies that
provide services or expand markets in traditional banking business. The primary
purpose for non-strategic investments is to achieve an economic return, with
secondary consideration given to matters, such as providing financing
opportunities, other banking relationships, and potential advisory fee income
for capital raising and buy/sell engagements. Provident's total investment in
these equity funds and direct equity investments as of December 31, 2003 totaled
$42 million which is also Provident's potential exposure to loss.
60
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Securitization trusts, which were formed as a result of securitization
transactions accounted for as sales from 1997 to 2000, are not within the scope
of FIN 46R and therefore have not been consolidated. As such, loans and leases
sold within these transactions have been removed from the balance sheet. The
following table provides a summary of the outstanding balances of these
off-balance sheet loans and leases:
December 31,
------------------------------
(In Thousands) 2003 2002
- ---------------------------------------- ---------- ----------
Nonconforming Residential $1,169,763 $1,779,127
Prime Home Equity 133,472 194,775
Equipment Leases 41,363 94,408
---------- ----------
$1,344,598 $2,068,310
========== ==========
In connection with the recognition of non-cash gains on securitizations
accounted for as sales, the present value of future cash flows, referred to as
retained interest in securitized assets, was recorded as an asset within
Investment Securities Available For Sale.
Additionally, Provident provides for a liquidity commitment to its nonconforming
residential securitizations, treated as sales, in the form of an unfunded demand
note backed by a AAA rated standby letter of credit. The commitment is
maintained to improve the credit grade of the securitization and thereby reduce
the rate paid to investors of the securitization trust. The unfunded demand note
is an asset of the securitization trust as well as a liability of Provident. As
such, Provident records the amount of the unfunded demand note as a liability.
As Provident owns the residual interest of the securitization trust, the
estimate of the fair value of the interest includes an estimate of the amount of
the demand note which will be returned to Provident at the end of the
securitization transaction.
The components of the estimated fair value of the RISA as of December 31, 2003
follow:
Nonconforming Prime
(In Thousands) Residential Home Equity
- ------------------------------------------------ ------------- -----------
Estimated Cash Flows of Underlying Loans,
Net of Payments to Certificate Holders,
and Servicing and Insurance Expense $ 386,804 $ 7,835
Less:
Estimated Credit Loss (60,087) -
Discount to Present Value (113,753) (1,444)
--------- ---------
Carrying Value of RISA $ 212,964 $ 6,391
========= =========
As the RISA is classified as an available for sale investment security, it has
been adjusted to its fair value with the change in fair value recorded in other
comprehensive income. As of December 31, 2003 the fair value of the RISA exceeds
the amortized cost basis by $25.7 million, with resulted in an after-tax
increase to other comprehensive income of $16.7 million. The amortized cost
basis of the nonconforming residential RISA is $187.3 million.
Provident's prime home equity and equipment leasing securitizations are credit
enhanced in the form of cash collateral accounts that are maintained inside the
securitization vehicle. Detail of the cash collateral balances
61
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
held by the Trusts and the estimates of future losses are provided below as of
December 31, 2003:
Carrying Value Estimates
of Credit of Future
(In Thousands) Enhancements Losses
- ---------------------------------------------- ------------ ------------
Prime Home Equity $ 34,520 $ 365
Equipment Leases 33,236 468
------------ ------------
$ 67,756 $ 833
============ ============
At December 31, 2003, management believes the current carrying values of the
RISA, credit enhancements and estimates of future losses are properly stated.
The following sensitivity table provides the effects of an immediate 10% and 20%
adverse change to key economic assumptions on RISAs and loss estimates as of
December 31, 2003:
Nonconforming Prime Equipment
(Dollars in Millions) Residential Home Equity Leasing
- ------------------------------------------------ ------------ ------------ ------------
Peak Prepayment Speed Assumption (Annual Rate) 33% CPR 30% CPR n/a
Impact on Fair Value of 10% Adverse Change $ (11.5) $ (0.7) n/a
Impact on Fair Value of 20% Adverse Change $ (22.9) $ (1.3) n/a
Estimated Credit Loss Assumption
(Percentage of Original Balance) 6.47% 1.00% 5.76%
Impact on Fair Value of 10% Adverse Change $ (6.0) $ - $ (0.1)
Impact on Fair Value of 20% Adverse Change $ (12.0) $ (0.1) $ (0.2)
RISA Discount Rate 9.47% 6.25% n/a
Impact on Fair Value of 10% Adverse Change $ (2.8) $ (0.1) n/a
Impact on Fair Value of 20% Adverse Change $ (5.6) $ (0.1) n/a
These sensitivities are hypothetical and should be used with caution. The effect
of a variation in a particular assumption on the fair value of the RISA and loss
estimates is calculated without changing any other assumption; in reality,
changes in one factor may result in changes in another, which might magnify or
counteract the sensitivities.
The following table presents quantitative information about delinquencies, net
credit losses and components of securitized and portfolio loans and leases:
2003 2002
------------------------------------------- -------------------------------------------
Middle Market Middle Market
Nonconforming Prime Home Equipment Nonconforming Prime Home Equipment
(Dollars in Thousands) Residential Equity Leases Residential Equity Leases
- ----------------------------- ---------- ---------- ---------- ---------- ---------- ----------
Average Assets:
Securitized and Sold $1,471,661 $ 162,310 $ 66,378 $2,190,684 $ 246,163 $ 150,562
Portfolio and Held for sale 405,822 1,519,339 1,047,555 808,822 853,860 957,835
---------- ---------- ---------- ---------- ---------- ----------
Total Managed Assets $1,877,483 $1,681,649 $1,113,933 $2,999,506 $1,100,023 $1,108,397
========== ========== ========== ========== ========== ==========
Year-End Assets:
Securitized and Sold $1,169,763 $ 133,472 $ 41,363 $1,779,127 $ 194,775 $ 94,408
Portfolio and Held for Sale 122,518 1,484,376 1,130,314 657,204 1,110,728 1,046,640
---------- ---------- ---------- ---------- ---------- ----------
Total Managed Assets $1,292,281 $1,617,848 $1,171,677 $2,436,331 $1,305,503 $1,141,048
========== ========== ========== ========== ========== ==========
Net Charge-Offs on
Total Managed Assets $ 147,290 $ 2,290 $ 18,069 $ 131,462 $ 3,422 $ 20,184
========== ========== ========== ========== ========== ==========
Net Charge-Offs to
Average Managed Assets 7.85% 0.14% 1.62% 4.38% 0.31% 1.82%
========== ========== ========== ========== ========== ==========
90 Days or More
Delinquencies to
Year-End Managed Assets 27.68% 0.19% 0.04% 17.85% 0.19% 0.38%
========== ========== ========== ========== ========== ==========
62
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - INVESTMENT SECURITIES: EITF Issue No. 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments,"
requires certain quantitative and qualitative disclosures for debt and equity
securities that are impaired at the balance sheet date but for which an
other-than-temporary impairment has not been recognized. The following table
provides amortized cost and estimated market values of securities available for
sale at year-end. December 31, 2003 balances are segregated by investments that
have been in a continuous unrealized loss position for more than twelve months
from investments that have been in an unrealized loss position for less than
twelve months or have unrealized gains.
Gross Gross Estimated
Amortized Unrealized Unrealized Market
(In Thousands) Cost Gains Losses Value
- --------------------------------------- ------------ ------------ ------------ ------------
2003 - Investments with an Unrealized
Gain Position or Unrealized Loss
Position for Less Than Twelve Months:
U.S. Treasury and Federal Agency
Debentures $ 608,808 $ 3,599 $ (1,285) $ 611,122
State and Political Subdivisions 1,360 40 - 1,400
Mortgage-Backed Securities 3,199,805 26,344 (46,418) 3,179,731
Other Securities 691,560 10 (5,140) 686,430
------------ ------------ ------------ ------------
$ 4,501,533 $ 29,993 $ (52,843) $ 4,478,683
============ ============ ============ ============
2003 - Investments with a Continuous
Unrealized Loss Position for More
Than Twelve Months:
Mortgage-Backed Securities $ 50,312 $ - $ (22,813) $ 27,499
Other Securities 22,632 - (902) 21,730
------------ ------------ ------------ ------------
$ 72,944 $ - $ (23,715) $ 49,229
============ ============ ============ ============
2002 - All Investments:
U.S. Treasury and Federal Agency
Debentures $ 310,244 $ 5,974 $ (75) $ 316,143
State and Political Subdivisions 1,838 40 (3) 1,875
Mortgage-Backed Securities 3,240,192 70,043 (18,723) 3,291,512
Other Securities 606,237 10 (539) 605,708
------------ ------------ ------------ ------------
$ 4,158,511 $ 76,067 $ (19,340) $ 4,215,238
============ ============ ============ ============
Mortgage-backed securities with a continuous unrealized loss for over one year
are comprised of two securities. Both securities are comprised of securitized
pools of residential and commercial mortgage loans and bonds. The market value
deterioration resulted from a combination of i) significant increases in
prepayment speeds on the underlying mortgage loans during the declining rate
environment since 2000; and ii) credit default issues within the underlying
component loans and bonds that comprise these securities. However, these
securities are rated "AAA", and are guaranteed to have the principal repaid by
other components of the securities which are U.S. Treasury and Agency Strips.
While Provident anticipates the market value deterioration experienced since the
securities' purchase in 1998 and 2000 to continue, no principal loss is expected
due to the securities' credit enhanced structure. In a worst case scenario,
these securities will mature in 2021 and 2030 at their par value. The company
has the intent and ability to hold these securities until the market value has
substantially recovered.
Other securities with a continuous unrealized loss for over twelve months is the
company's seed investment in a proprietary fixed income mutual fund family. The
net asset value loss is the result of the effect of interest rate movements on
the underlying fixed income investments in the fund. The company has the intent
and ability to hold these securities until the value has substantially
recovered.
63
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Investment securities with a carrying value of approximately $2.8 billion and
$2.6 billion at December 31, 2003 and 2002, respectively, were pledged as
collateral to secure public and trust deposits, repurchase agreements,
extensions of credit by the Federal Home Loan Bank, interest rate derivatives
and for other purposes.
In 2003, 2002 and 2001 gross gains of $48.5 million, $9.2 million and $10.3
million and gross losses of $3.0 million, $6.6 million and $10.3 million,
respectively, were realized on the sale of securities available for sale. In
addition, Provident recognized RISA and equity investment write-downs of $39.2
million during 2003.
Securities are shown below based on their estimated average lives at December
31, 2003. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.
Amortized Estimated
(In Thousands) Cost Market Value
- -------------- --------- ------------
Due in one year or less $ 440,042 $ 441,335
Due after 1 through 5 years 3,114,284 3,104,650
Due after 5 through 10 years 553,031 541,529
Due after 10 years 467,120 440,398
---------- ----------
Total $4,574,477 $4,527,912
========== ==========
NOTE 5 - LEASING: Provident originates leases which are classified as either
finance leases or operating leases, based on the terms of the lease arrangement.
When a lease is classified as a finance lease, the future lease payments, net of
unearned income, and the estimated residual value of the leased property at the
end of the lease term are recorded as an asset under Loans and Leases. The
amortization of the unearned income is recorded as interest income. When a lease
is classified as an operating lease, the costs of the leased property, net of
depreciation, is recorded as Leased Equipment. Rental income is recorded as
noninterest income while the depreciation on the leased property is recorded as
noninterest expense. At the expiration of a lease, the leased property is sold
or another lease agreement is initiated.
Lease Financing: Lease financing includes the leasing of transportation,
manufacturing, construction, communication, data processing, medical, office
equipment and vehicles. These leases are classified as direct financing leases,
with expiration dates over the next 1 to 9 years. Rentals receivable at December
31, 2003 and 2002 include $57 million and $81 million, respectively, for
leveraged leases, which is net of principal and interest on the nonrecourse
debt. The residual values on the leveraged leases that were entered into are
estimated to be approximately $66 million and $110 million in total at December
31, 2003 and 2002, respectively.
64
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The components of the net investment in lease financing at December 31 were as
follows:
2003 2002
--------------------------------- --------------------------
(In Thousands) Commercial Consumer Commercial Consumer
- -------------- ----------- ----------- ----------- --------
Rentals Receivable $ 1,352,071 $ 322,460 $ 1,322,470 $ --
Estimated Residual Values 132,267 194,263 171,482 --
----------- ----------- ----------- ------
1,484,338 516,723 1,493,952 --
Less: Unearned Income (209,083) (56,421) (220,051) --
----------- ----------- ----------- ------
Net Investment $ 1,275,255 $ 460,302 $ 1,273,901 $ --
=========== =========== =========== ======
The following is a schedule by year of future minimum lease payments to be
received on lease financing for the next five years as of December 31, 2003:
(In Thousands) Commercial Consumer
- -------------- ---------- ----------
2004 $ 493,514 $ 76,421
2005 357,870 75,685
2006 212,300 74,644
2007 112,353 61,208
2008 72,704 30,931
Thereafter 103,330 3,571
---------- ----------
Total $1,352,071 $ 322,460
========== ==========
Leased Equipment: Leased equipment includes assets which are subject to
operating leases. Operating leases are comprised of transportation equipment,
manufacturing equipment, data processing, medical and office equipment to
commercial clients and vehicles, some of which are accounted for as assets under
a capital lease.
Provident, utilizing its auto leases, has entered into sale-leaseback
transactions. At December 31, 2003 and 2002, respectively, approximately $0.9
billion and $1.5 billion of auto leases which were utilized in these
transactions were outstanding and represent assets under capital leases included
in Leased Equipment.
A summary of leased equipment at December 31 follows:
2003 2002
--------------------------------- ---------------------------------
(In Thousands) Commercial Consumer Commercial Consumer
- -------------- ----------- ----------- ----------- -----------
Cost $ 355,880 $ 2,205,913 $ 366,982 $ 2,905,969
Accumulated Depreciation (111,070) (797,459) (100,885) (821,710)
----------- ----------- ----------- -----------
244,810 1,408,454 266,097 2,084,259
=========== =========== =========== ===========
The future gross minimum rentals, by year, under noncancelable leases for the
rental of leased equipment follows:
(In Thousands) Commercial Consumer
- -------------- ---------- --------
2004 $ 59,540 $ 314,327
2005 46,390 220,151
2006 28,113 117,138
2007 13,319 38,759
2008 5,122 4,567
Thereafter 2,462 137
--------- ---------
Total $ 154,946 $ 695,079
========= =========
65
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In 2003, 2002 and 2001, respectively, Provident incurred impairment charges of
$0.3 million, $1.9 million and $5.7 million on uninsured auto residuals.
Impairment is determined on an individual unit basis. Since 1994, except for a
five-month period during 1998, when it self-insured, Provident has maintained
insurance on its auto lease residuals in amounts necessary to effectively remove
residual risk.
NOTE 6 - RESERVE FOR LOAN AND LEASE LOSSES: The changes in the loan and lease
loss reserve for the years ended December 31 were as follows:
(In Thousands) 2003 2002 2001
- -------------- --------- --------- ---------
Balance at Beginning of Period $ 201,051 $ 241,143 $ 159,118
Provision for Loan and Lease Losses
Charged to Earnings 115,979 99,549 215,545
Acquired Reserves -- -- 10,003
Recoveries Credited to the Reserve 20,144 26,220 12,057
--------- --------- ---------
337,174 366,912 396,723
Losses Charged to the Reserve (177,174) (165,861) (155,580)
--------- --------- ---------
Balance at End of Period $ 160,000 $ 201,051 $ 241,143
========= ========= =========
The following table shows Provident's investment in impaired loans as defined
under Statement 114 as amended by Statement 118:
(In Thousands) 2003 2002
- -------------- -------- --------
Impaired Loans Requiring a Valuation Allowance of
$15.0 Million in 2003 and $29.4 Million in 2002 $ 54,247 $ 91,053
Impaired Loans Not Requiring a Valuation Allowance 8,391 8,272
-------- --------
Total Impaired Loans $ 62,638 $ 99,325
======== ========
Average Impaired Loans for the Year $105,583 $102,241
======== ========
The decrease in impaired loans reflects the sale of non-performing loans that
occurred in the fourth quarter of 2003. The largest impaired loan relates to the
commercial airline industry. The remaining impaired loans are distributed among
14 industries. Impaired loans are reviewed on an individual basis to estimate
potential future losses. As of December 31, 2003, reserves established for
impaired loans are believed to be sufficient to absorb future potential losses.
Interest income recognized on impaired loans during 2003 or 2002 was $0 and $0.2
million, respectively. The valuation allowance recorded on impaired loans is
included in the reserve for loan losses.
Loans and leases on nonaccrual status at December 31, 2003, 2002 and 2001 were
$79.9 million, $166.4 million and $176.9 million, respectively. Loans and leases
which were ninety days or more past due and still accruing totaled $12.7
million, $29.9 million and $30.3 million at December 31, 2003, 2002 and 2001,
respectively. No loans or leases had been renegotiated to provide a reduction or
deferral of interest or principal as of December 31, 2003, 2002 and 2001.
66
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - PREMISES AND EQUIPMENT: The following is a summary of premises and
equipment at December 31:
(In Thousands) 2003 2002
- -------------- --------- ---------
Land $ 10,301 $ 11,921
Buildings 38,954 40,698
Leasehold Improvements 19,448 19,092
Furniture and Fixtures 189,528 179,016
--------- ---------
258,231 250,727
Less Depreciation and Amortization (165,394) (149,214)
--------- ---------
Total $ 92,837 $ 101,513
========= =========
Rent expense for all bank premises and equipment leases was $17.0 million, $15.2
million and $15.1 million in 2003, 2002 and 2001, respectively. The future gross
minimum rentals, by year, under noncancelable leases for the rental of premises
and equipment are $14.3 million in 2004, $13.3 million in 2005, $12.6 million in
2006, $10.7 million in 2007, $10.3 million in 2008 and $50.4 million thereafter.
NOTE 8 - GOODWILL AND OTHER INTANGIBLE ASSETS: Provident adopted the provisions
of Statement No. 141, "Business Combinations," and No. 142, "Goodwill and Other
Intangible Assets," on January 1, 2002. Under these rules, goodwill and
intangible assets deemed to have indefinite lives are not amortized but are
subject to annual impairment tests in accordance with Statement 142. Other
intangible assets determined to have limited lives continue to be amortized over
their useful lives. Management performed an impairment test on its goodwill
assets as of January 1, 2003 and 2002 and determined that no impairment existed
as of those dates.
As a result of adopting Statement 142, Provident did not incur any goodwill
amortization during 2003 and 2002, whereas during 2001, Provident recorded
goodwill amortization. The following table provides net income and earnings per
share for the year ended December 31, 2001 on a pro forma basis excluding
goodwill amortization.
Year Ended
December 31,
(In Thousands, Except Per Share Amounts) 2001
- ---------------------------------------- ------------
Net Income (Loss):
As Reported $ (1,003)
Add Back: After-Tax Goodwill Amortization 2,806
--------
Pro-Forma Net Income $ 1,803
========
Basic Earnings (Loss) Per Common Share:
As Reported $ (0.04)
Add Back: After-Tax Goodwill Amortization 0.06
--------
Pro-Forma Basic Earnings Per Common Share $ 0.02
========
Diluted Earnings (Loss) Per Common Share:
As Reported $ (0.04)
Add Back: After-Tax Goodwill Amortization 0.06
--------
Pro-Forma Diluted Earnings Per Common Share $ 0.02
========
67
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Changes in the carrying amount of goodwill by business line for the years ended
December 31, 2003 and 2002, are as follows:
Commercial Retail
(In Thousands) Banking Banking Total
- -------------- ---------- -------- --------
Balance at January 1, 2002 $ 39,825 $ 40,824 $ 80,649
Goodwill Acquired During the Year -- 189 189
Goodwill Recorded as a Result of Contingent --
Consideration being Recognized 1,594 219 1,813
-------- -------- --------
Balance at December 31, 2002 41,419 41,232 82,651
Goodwill Recorded as a Result of Contingent
Consideration being Recognized 1,329 289 1,618
Goodwill Included in the Sale of Florida
Assets and Liabilities -- (2,468) (2,468)
-------- -------- --------
Balance at December 31, 2003 $ 42,748 $ 39,053 $ 81,801
======== ======== ========
As all of Provident's other intangible assets have been determined to have
limited lives, these assets have continued to be amortized as in the past.
Intangible assets, consisting of non-contractual customer relationships, had a
gross carrying value of $16.0 million and accumulated amortization of $9.4
million resulting in a net carrying value of $6.6 million as of December 31,
2003. Amortization of intangible assets was $4.4 million, $4.7 million and $3.4
million for the years ended December 31, 2003, 2002 and 2001, respectively. The
estimated amortization of intangible assets for the next five years is $3.2
million for 2004; $2.1 million for 2005; $0.7 million for 2006; $0.2 million for
2007; and $0.2 million for 2008.
NOTE 9 - MORTGAGE SERVICING ASSETS: Provident recognizes the rights to service
mortgage loans it does not own but services for others within Other Assets of
its balance sheet. Mortgage servicing assets may be recognized (1) when mortgage
loans are sold with servicing retained or (2) when mortgage loan servicing is
purchased. When mortgage loans are sold with servicing retained, the carrying
value of the loans is allocated between the loans sold and servicing assets
retained based on the relative fair values of each. Mortgage servicing assets,
when purchased, are initially recorded at cost. Mortgage servicing assets are
carried at the lower of the initial carrying value, adjusted for amortization,
or estimated fair value. Mortgage servicing assets are evaluated quarterly for
impairment based on the fair value of those assets, using a disaggregated
approach based on interest rates and product types. The fair value of the
mortgage servicing assets is determined by estimating the present value of
future net cash flows, taking into consideration loan prepayments speeds,
discount rates, servicing costs and other economic factors.
68
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Changes in the net carrying value of mortgage servicing assets follows:
Year Ended
December 31,
-----------------------------
(In Thousands) 2003 2002
- -------------- --------- ---------
Mortgage Servicing Assets:
Balance at Beginning of Period $ 112,229 $ 84,267
Capitalized 85,452 46,139
Amortization (34,579) (17,098)
Sales / Loan Payoffs (3,932) (1,079)
Permanent Impairment Write-Off (304) --
--------- ---------
Balance at End of Period $ 158,866 $ 112,229
========= =========
Valuation Allowance:
Balance at Beginning of Period $ (539) $ --
Servicing Valuation Provision (1,844) (539)
Permanent Impairment Write-Off 304 --
--------- ---------
Balance at End of Period $ (2,079) $ (539)
========= =========
Net Carrying Value of Mortgage Servicing --------- ---------
Assets at End of Period $ 156,787 $ 111,690
========= =========
As of December 31, 2003, total mortgage loans serviced for others included $11.3
billion on residential property and $9.7 billion on commercial real estate
property. Net mortgage servicing assets relating to residential loans and
commercial real estate loans totaled $82.1 million and $74.7 million,
respectively as of December 31, 2003. Net impairment charges of $1.1 million and
$0.5 million were incurred on the residential servicing assets in 2003 and 2002,
respectively. In 2003, impairment charges of $0.7 million were incurred on the
commercial real estate assets. Impairment charges on mortgage servicing assets
have been less significant for Provident than at some other mortgage servicers
due to characteristics of the underlying loans being serviced. The majority of
the residential loans were acquired with interest rates at or near current
levels while most of the commercial real estate loans have lockout and
prepayment penalties generally ranging from 5 to 9 years.
NOTE 10 - SHORT-TERM DEBT: Short-term debt was as follows:
(Dollars in Thousands) 2003 2002 2001
- ---------------------- ---------- ---------- ----------
Year End Balance:
Federal Funds Purchased and Repurchase Agreements $1,182,385 $1,653,736 $1,644,738
Commercial Paper 261,053 271,269 240,571
Weighted Average Interest Rate at Year End:
Federal Funds Purchased and Repurchase Agreements 2.35% 1.98% 2.28%
Commercial Paper 0.96 1.49 1.67
Maximum Amount Outstanding at Any Month End:
Federal Funds Purchased and Repurchase Agreements $1,861,603 $1,701,716 $1,925,001
Commercial Paper 298,755 310,029 273,898
69
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - LONG-TERM DEBT: Long-term debt consisted of the following:
December 31,
Stated Effective Maturity ------------------------------
(Dollars in Thousands) Rate (1) Rate (2) Date 2003 2002
- ---------------------- -------- --------- -------- ---------- ----------
Provident (Parent Company):
Fixed Rate Senior 8.38% 3.49% 2032 $ 75,000 $ 75,000
Miscellaneous Notes Various Various Various 120 239
---------- ----------
75,120 75,239
---------- ----------
Subsidiaries:
Notes Payable to
Federal Home Loan Bank:
Fixed Rate 5.84 5.84 2009 252,933 253,076
Fixed Rate 5.96 5.96 2010 280,000 420,000
Fixed Rate Various Various Various 48,563 55,589
Subordinated Notes:
Fixed Rate n/a n/a 2003 -- 74,998
Fixed Rate 6.38 1.49 2004 99,997 99,932
Secured Debt Financings:
Secured by Auto Leases (3) n/a n/a 2003 -- 125,354
Secured by Auto Leases (3) n/a n/a 2003 -- 42,325
Secured by Auto Leases (3) 5.76 .43 2004 38,863 55,029
Secured by Auto Leases (3) 5.22 5.22 2004 100,901 244,585
Secured by Auto Leases (3) 5.96 5.96 2005 19,419 24,515
Secured by Auto Leases (3) 5.27 5.27 2005 107,496 130,263
Secured by Auto Leases (3) 6.37 6.37 2006 536,095 474,504
Secured by Auto Leases (3) 5.39 5.39 2007 22,717 26,700
Secured by Auto Leases (3) 6.00 6.00 2007 356,403 388,869
Secured by Auto Leases (3) 4.70 7.16 2007 215,847 249,020
Secured by Residential Properties 4.12 4.12 2004 10,775 --
Secured by Residential Properties 1.50 2.05 2005 991,585 986,536
Secured by Equipment Leases 1.50 1.50 2005 19,433 43,073
Miscellaneous Notes Various Various Various 122,783 73,050
---------- ----------
3,223,810 3,767,418
---------- ----------
Total $3,298,930 $3,842,657
========== ==========
(1) Stated rate reflects interest rate on notes as of December 31, 2003.
(2) Effective rate reflects interest rate paid as of December 31, 2003 after
adjustments for notes issued at discount or premium, capitalized fees
associated with the issuance of the debt and interest rate swap agreements
entered to alter the payment characteristics.
(3) Capital lease obligations incurred under sale-leaseback arrangement.
During the third quarter of 2002, Provident issued $75 million of senior
unsecured notes. These notes mature on July 15, 2032, however, they may be
called in whole or in part at any time on or after July 15, 2007.
The notes payable to the Federal Home Loan Bank are collateralized by investment
securities with a book value of $611 million. They are subordinated to the
claims of depositors and other creditors of Provident and are not insured by the
FDIC.
During 2003 Provident retired $140 million of Federal Home Loan Bank debt and
approximately $152 million of secured debt financing. Costs of $25.6 million
were associated with the retirement of this debt. Subordinated notes of $75
million matured during 2003.
Many of Provident's securitizations of loans and leases have been structured to
account for the transactions as secured financings. In connection with these
transactions, Provident has pledged $1.4 billion in auto leases, $1.1 billion in
residential and home equity loans, $110 million in cash and $27 million in
equipment leases.
70
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2003, scheduled principal payments on long-term debt for the
following five years were as follows:
(In Thousands) 2004 2005 2006 2007 2008
- -------------- ---------- ---------- ---------- ---------- ----------
Provident (Parent Company) $ 120 $ -- $ -- $ -- $ --
Subsidiaries 498,317 1,276,186 449,025 376,224 26,053
NOTE 12 - JUNIOR SUBORDINATED DEBENTURES AND GUARANTEED PREFERRED BENEFICIAL
INTERESTS IN COMPANY'S JUNIOR SUBORDINATED DEBENTURES: Provident Capital Trust
I, II, III and IV, combined, were formed through the issuance of $14.3 million
of common stock and $462.5 million of preferred stock. The common stock was
purchased by Provident while the preferred stock was purchased by outside
investors. The proceeds of these stock sales were used to purchase $476.8
million of newly-authorized Provident junior subordinated debentures. The
debentures provide interest and principal payments to fund the trusts'
obligations. Provident fully and unconditionally guarantees the preferred
securities. The preferred securities qualify as either Tier 1 or Tier 2 capital
for bank regulatory purposes. The sole assets of the trusts are the debentures.
As a result of new accounting rules implemented by FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities," Provident de-consolidated the
trusts as of December 31, 2003. This resulted in Provident recording an
investment in the Provident Capital Trust companies, which is included in Other
Assets, and recording additional debt equal to the common stock purchased by
Provident as of December 31, 2003. The junior subordinated debentures consisted
of the following at December 31:
December 31,
Stated Effective Maturity --------------------------
(Dollars in Thousands) Rate Rate (1) Date 2003 2002
- ---------------------- ------ --------- --------- -------- --------
November 1996 Issuance 8.60% 8.67% 12/01/26 $102,137 $ 99,003
June 1999 Issuance 8.75% 2.46% 06/30/29 125,519 121,522
November 2000 Issuance 10.25% 3.83% 12/31/30 112,853 109,257
March 2001 Issuance 9.45% 4.11% 03/30/31 125,290 121,292
-------- --------
Total $465,799 $451,074
======== ========
(1) Effective rate reflects interest rate paid as of December 31, 2003 after
adjustments for notes issued at discount or premium, capitalized fees
associated with the issuance of the debt and interest rate swap agreements
entered to alter the payment characteristics.
NOTE 13 - MINORITY INTEREST: During June 2002, Provident and its consolidated
subsidiary, PFGI Capital Corporation (PFGI Capital), issued 6.6 million equity
units (PRIDES) to outside investors for $165 million. Provident Bank owns all of
the $165 million of Common Stock of PFGI Capital. The principal business
objective of PFGI Capital is to hold and manage commercial mortgage loan assets
and other authorized investments acquired from Provident Bank that will generate
net income for distribution to its stockholders. PFGI Capital has elected to be
treated as a real estate investment trust (REIT) for federal income tax
purposes.
Each PRIDES has a stated amount of $25 per unit and is comprised of two
components - a 3-year forward purchase contract and PFGI Capital Preferred
Stock.
71
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Each forward purchase contract obligates the holder to buy, on August 17, 2005,
for $25, a number of newly issued shares of Provident Common Stock equal to the
"settlement rate." The settlement rate will be calculated as follows:
- - if the market value of Provident Common Stock is equal to or greater than
$29.0598, the settlement rate will be 0.8603;
- - if the market value of Provident Common Stock is between $29.0598 and $24.42,
the settlement rate will be equal to the $25 stated amount divided by the
applicable market value; and
- - if the applicable market value is less than or equal to $24.42, the settlement
rate will be 1.0238.
"Applicable market value" is defined as the average of the closing price per
share of Provident Common Stock on each of the twenty consecutive trading days
ending on the fifth trading day immediately preceding August 17, 2005.
The following table illustrates how the settlement rate impacts the total number
of shares of Provident Common Stock that will be issued under the forward
purchase contract and the calculated price per share:
Applicable Market Value Less Than Greater Than
of Provident Common Stock $24.42 $25.00 $28.00 $29.0598
- ------------------------- ------------ ------------ ------------ --------------
Settlement Rate (25.00/24.42) (25.00/25.00) (25.00/28.00) (25.00/29.0598)
1.0238 1.0000 0.8929 0.8603
Total Purchased Contracts
Outstanding 6,600,000 6,600,000 6,600,000 6,600,000
------------ ------------ ------------ ------------
Shares of Provident
Common Stock Purchased 6,757,080 6,600,000 5,893,140 5,677,980
============ ============ ============ ============
Total Proceeds Received
From PFGI Preferred
Stock Issuance $165,000,000 $165,000,000 $165,000,000 $165,000,000
Shares of Provident
Common Stock Purchased 6,757,080 6,600,000 5,893,140 5,677,980
------------ ------------ ------------ ------------
Price Paid Per Share of
Provident Common Stock $ 24.42 $ 25.00 $ 28.00 $ 29.06
============ ============ ============ ============
Under the forward purchase contract, Provident will also make quarterly contract
adjustment payments to the PRIDES holders at the rate of 1.25% of the stated
amount per year. The present value of this obligation has been recorded as a
liability and as a reduction to shareholders' equity.
The PFGI Capital Preferred Stock has a liquidation preference of $25 and an
initial non-cumulative dividend rate of 7.75%. Under certain regulatory
circumstances, the PFGI Capital Preferred Stock will be automatically exchanged
for Provident Bank Preferred Stock.
72
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Concurrent with the fulfillment of the forward purchase contract, Provident has
engaged a remarketing agent to remarket the PFGI Capital Preferred Stock on
behalf of the holders, at which time the PFGI Capital Preferred Stock is
permanently detached from the forward purchase contract. Once the forward
purchase contract is fulfilled, there will be two separate and distinct
securities outstanding: PFGI Capital Preferred Stock and Provident Common Stock.
The number of common shares to be issued will be from 5,677,980 to 6,757,080,
depending on the market value of the Common Stock. The proceeds received from
the remarketing will be used by the holders of PFGI Capital Preferred Stock to
fulfill their commitment under the terms of the forward purchase contract.
Provident intends to use such proceeds for the redemption of the remarketed PFGI
Capital Preferred Stock ninety days after the remarketing.
As discussed in Note 24 of the "Notes to Consolidated Financial Statements,"
Provident will merge with National City Corporation (National City) subject to
regulatory and stockholder approvals. National City will be required to
expressly assume Provident's obligations under the forward purchase contract and
certain related agreements. As Provident shareholders will be receiving 1.135
shares of National City Common Stock for each share of Provident Common Stock,
the settlement rate of the forward purchase contract will be calculated as
follows:
- - if the market value of National City Common Stock is equal to or greater
than $25.6033, the settlement rate will be 0.9764;
- - if the market value of National City Common Stock is between $25.6033 and
$21.5154, the settlement rate will be equal to the $25 stated amount
divided by the applicable market value; and
- - if the applicable market value is less than or equal to $21.5154, the
settlement rate will be 1.1620.
NOTE 14 - STOCKHOLDERS' EQUITY: In 1991, Provident issued 371,418 shares of
Non-Voting Convertible Preferred Stock to American Financial Group as partial
consideration for the acquisition of Hunter Savings Association. During 1995,
301,146 shares of the Preferred Stock were converted into 4,234,865 shares of
Common Stock. As of December 31, 2003 and 2002, 70,272 shares of Preferred Stock
remain outstanding. These shares have a stated value and liquidation value of
$100 per share and a conversion ratio of 14.0625 shares of Provident's Common
Stock for each share of Convertible Preferred Stock.
73
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Comprehensive income represents the changes in equity during a period except
those resulting from investments by shareholders and distributions to
shareholders. For Provident, components of comprehensive income include the
unrealized gains/losses on securities available for sale and unrealized
gains/losses on cash flow hedging derivatives (collectively known as other
comprehensive income), as well as net income. A summary of activity in
accumulated other comprehensive income (loss) within Shareholders' Equity
follows:
(In Thousands) 2003 2002
- -------------- -------- --------
Accumulated Unrealized Losses on Securities Available
for Sale at January 1, Net of Tax $ 36,809 $(15,953)
Net Unrealized Gains (Losses) for the Period, Net of Tax
(Benefit) Expense of ($22,509) in 2003 and $29,319 in 2002 (41,803) 54,449
Reclassification Adjustment for Gains Included in Net Income,
Net of Tax Expense of $13,581 in 2003 and $909 in 2002 (25,222) (1,687)
-------- --------
Effect on Other Comprehensive Income (Loss) for the Year (67,025) 52,762
-------- --------
Accumulated Unrealized Gains (Losses) on Securities Available
for Sale at December 31, Net of Tax $(30,216) $ 36,809
======== ========
Accumulated Unrealized Losses on Derivatives Used in Cash
Flow Hedging Relationships at January 1, Net of Tax $(79,930) $(82,743)
Net Unrealized Gains (Losses) for the Period, Net of Tax
(Benefit) Expense of $4,864 in 2003 and ($13,117) in 2002 9,033 (24,360)
Reclassification Adjustment for Losses Included in Net Income,
Net of Tax Benefit of $11,195 in 2003 and $14,632 in 2002 20,791 27,173
-------- --------
Effect on Other Comprehensive Income (Loss) for the Year 29,824 2,813
-------- --------
Accumulated Unrealized Losses on Derivatives Used in Cash
Flow Hedging Relationships at December 31, Net of Tax $(50,106) $(79,930)
======== ========
Accumulated Other Comprehensive Income (Loss) at
January 1, Net of Tax $(43,121) $(98,696)
Other Comprehensive Income (Loss), Net of Tax (37,201) 55,575
-------- --------
Accumulated Other Comprehensive Income (Loss) at
December 31, Net of Tax $(80,322) $(43,121)
======== ========
NOTE 15 - REGULATORY CAPITAL REQUIREMENTS: Provident and its banking subsidiary,
Provident Bank, are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on Provident's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, Provident
and Provident Bank must meet specific capital guidelines that involve
quantitative measures of its assets, liabilities and certain off-balance sheet
items as calculated under regulatory accounting practices. Capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require Provident and Provident Bank to maintain minimum ratios of 4.00% for
Tier 1 capital to average assets, 4.00% for Tier 1 capital to risk-weighted
assets, and 8.00% for total risk-based capital to risk-weighted assets. As of
December 31, 2003, Provident and Provident Bank meet all capital requirements to
which they are subject.
74
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2003, Provident and Provident Bank's capital ratios were
categorized as "well capitalized" for regulatory purposes. To be categorized as
well capitalized, Provident and Provident Bank must maintain minimum ratios of
5.00% for Tier 1 capital to average assets, 6.00% for Tier 1 capital to
risk-weighted assets, and 10.00% for total risk-based capital to risk-weighted
assets. There have been no subsequent conditions or events which management
believes have changed the institutions' status.
The following table presents Provident and Provident Bank's regulatory capital
information at December 31:
2003 2002
--------------------------------- ---------------------------------
Provident Provident
(Dollars in Thousands) Provident Bank Provident Bank
- ---------------------- ----------- ----------- ----------- -----------
Tier 1 Capital $ 1,411,771 $ 1,207,005 $ 1,337,158 $ 1,151,075
Average Assets 17,369,271 17,246,757 17,119,102 16,996,303
Tier 1 Leverage Ratio 8.13% 7.00% 7.81% 6.77%
Tier 1 Capital $ 1,411,771 $ 1,207,005 $ 1,337,158 $ 1,151,075
Risk-Weighted Assets 13,333,797 13,234,462 14,225,716 14,059,727
Tier 1 Capital Ratio 10.59% 9.12% 9.40% 8.19%
Total Risk-Based Capital $ 1,658,388 $ 1,622,015 $ 1,625,270 $ 1,596,938
Risk-Weighted Assets 13,333,797 13,234,462 14,225,716 14,059,727
Total Risk-Based Capital Ratio 12.44% 12.26% 11.42% 11.36%
Provident's Tier 1 capital is comprised of total shareholders' equity plus
qualifying minority interest and junior subordinated debentures, less unrealized
gains and losses within accumulated other comprehensive loss, intangible assets,
and a valuation related to mortgage servicing rights. Total risk-based capital
consists of Tier 1 capital plus qualifying reserves for loan and lease losses
and junior subordinated debentures which did not qualify for Tier 1 treatment.
For purposes of computing the leverage ratio, average assets represents average
assets for the fourth quarter less assets not qualifying for total risk-based
capital including intangibles and non-qualifying mortgage servicing assets and
reserve for loan and lease losses.
NOTE 16 - BENEFIT PLANS: Provident has a Retirement Plan for the benefit of its
employees. Included under this plan is a Profit Sharing Plan and a Personal
Investment Election Plan (PIE Plan). Provident also maintains a Deferred
Compensation Plan (DCP) and stock option plans.
The Profit Sharing Plan covers all employees who are qualified as to age and
length of service. It is a trusteed plan with the entire cost borne by
Provident. All fund assets are allocated to the participants. Provident's
contributions are discretionary by the directors of Provident. Provident
contributed approximately $5.5 million and $4.6 million for 2003 and 2002,
respectively. Contributions of $4.1 million were made to an Employee Stock
Ownership Plan (ESOP) for 2001. The Profit Sharing Plan, which replaced the
ESOP, differs from the ESOP in that participants may diversify contributions,
which were formerly in Provident Stock, to other kinds of investments. In
addition, participants may diversify up to 25% of their year-end 2002 ESOP
balance each year into other investment options.
75
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The PIE Plan, a tax deferred retirement plan, covers all employees who are
qualified as to age and length of service. Employees who wish to participate in
the PIE Plan may contribute from 1% to 10% (15% beginning in 2003) of their
pre-tax salaries (to a maximum prescribed by the Internal Revenue Service) to
the plan as voluntary contributions. Provident will make a matching contribution
equal to 25% of the pre-tax voluntary contributions made by the employees on the
first 8% of their pre-tax salaries during the plan year. The contribution made
by Provident is charged against earnings as the employees' contributions are
made. Provident incurred expense of $1.9 million, $1.7 million and $1.5 million
for this retirement plan for 2003, 2002 and 2001, respectively.
The DCP permits participants, selected by the Compensation Committee of the
Board of Directors, to defer compensation in a manner that aligns their
interests with those of Provident shareholders through the investment of
deferred compensation in Provident Common Stock. The DCP allows participants to
postpone the receipt of 5% to 50% of compensation until retirement. Amounts
deferred are invested in a Provident Bank Stock Account or a Self-Directed
Account. Provident will credit the Stock Account with an amount dependent upon
Provident's pre-tax earnings per share, for each share of Provident Common Stock
in the account. The calculated credit is charged against earnings by Provident
annually. Under the DCP, Provident paid $0 $195,000 and $0 for 2003, 2002 and
2001, respectively.
Provident has Employee Stock Option Plans, an Advisory Directors' Stock Option
Plan and Outside Directors' Stock Option Plans. The options are to be granted,
with exercise prices at market value, as of the date of grant. Options become
exercisable beginning one year from date of grant generally at the rate of 20%
per year. The Employee Stock Option Plans, Advisory Directors' Stock Option Plan
and Outside Directors' Stock Option Plans authorized the issuance of 13,342,373,
427,500 and 193,750 options, respectively. As of December 31, 2003, the number
of options remaining available for future issuance under all of the stock option
plans is 2.3 million.
The following table summarizes option activity for the three years ended
December 31, 2003:
2003 2002 2001
--------------------------------- --------------------------------- ---------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Number of Exercise Number of Exercise Number of
Price Options Price Options Price Options
-------------- ---------------- ------------- ------------------ ------------- -----------------
Outstanding at
Beginning of Year $29.12 7,127,235 $29.92 6,143,359 $28.84 5,480,365
Granted 27.55 1,144,240 23.08 1,660,200 29.17 1,407,432
Exercised 19.09 (335,718) 12.59 (336,295) 10.37 (374,567)
Canceled 29.25 (459,930) 30.33 (340,029) 30.82 (369,871)
------------- ------------- -------------
Outstanding at
End of Year $28.54 7,475,827 $29.12 7,127,235 $29.92 6,143,359
============= ============= =============
76
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2003, 2002 and 2001, there were 3,965,812, 3,297,934 and
2,825,462 options exercisable, respectively, having a weighted average option
price per share of $30.23, $31.27 and $28.61, respectively. The following table
summarizes information about stock options outstanding at December 31, 2003:
Options Outstanding Options Exercisable
-------------------------------------------------------------- --------------------------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life in Years Price Exercisable Price
- --------------- -------------------- --------------------- ---------------- -------------------- ---------------
$13.00 - $19.00 301,202 1.4 $15.17 301,202 $15.17
$19.01 - $28.00 4,184,727 7.0 25.11 1,678,100 25.05
$28.01 - $41.00 2,423,835 6.0 31.93 1,421,047 33.01
$41.01 - $55.00 566,063 4.0 46.58 565,463 46.59
As of January 1, 2003, Provident elected to adopt the provisions of Statement
No. 123, "Accounting for Stock-Based Compensation" using the Prospective Method
of expense recognition according to the transition rules of Statement No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure." Under
Statement 123, compensation expense is recognized over the vesting period equal
to the fair value of stock-based compensation as of the date of grant. Provident
recorded $1.3 million ($1.0 million after-tax) of stock-based compensation for
2003 while no compensation cost has been recognized for stock option grants
during 2002 and 2001. Pro forma net income and earnings per share information is
provided in Note 1 as if compensation cost had been determined for stock awards
for all years based on the fair values at grant dates.
NOTE 17 - INCOME TAXES: The composition of income tax expense follows:
(In Thousands) 2003 2002 2001
- ------------------------------------------- -------- ------- --------
Current:
Federal $ (8,318) $24,786 $ 11,704
State 2,147 2,686 (50)
-------- ------- --------
(6,171) 27,472 11,654
Deferred 53,316 22,550 (12,249)
-------- ------- --------
Total $ 47,145 $50,022 $ (595)
======== ======= ========
The effective tax rate differs from the statutory rate applicable to
corporations as a result of permanent differences between accounting and taxable
income. The reconciliation between income tax expense and the amount computed by
applying the statutory federal income tax rate was as follows:
(In Thousands) 2003 2002 2001
- -------------------------------------------- -------- -------- -------
Tax at Statutory Rate (35%) $ 50,766 $ 50,915 $ (557)
State Income Tax, Net of Federal Tax Benefit 1,396 1,746 (32)
Tax Effect of:
Non-Taxable Interest Income (3,392) (3,388) (512)
Securitization Activity (2,788) 1,950 227
Tax Credits (2,306) (2,638) (1,113)
Non-Deductible Amortization of Goodwill 864 258 1,257
Other - Net 2,605 1,179 135
-------- -------- -------
Applicable Income Taxes $ 47,145 $ 50,022 $ (595)
======== ======== =======
77
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In addition to the above income tax expense related to operations, an income tax
benefit of $0.6 million has been allocated to the cumulative effect of changes
in accounting principles.
At December 31, 2003, for income tax purposes, Provident had a federal net
operating loss carryforward of $133.8 million available, which expires in the
year 2021.
At December 31, 2003, Provident had a federal tax credit carryforward of $2.7
million available, which $0.4 million and $2.3 million expires in 2022 and 2023,
respectively.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
Provident's deferred tax liabilities and assets as of December 31 are as
follows:
(In Thousands) 2003 2002 2001
- ------------------------------------------ -------- -------- --------
Deferred Tax Liabilities:
Excess Lease and Partnership Income $244,921 $194,679 $143,267
Securitizations 52,386 109,585 58,433
Deferred Loan Costs 26,955 23,308 30,485
Other 30,918 23,829 19,225
-------- -------- --------
Total Deferred Tax Liabilities 355,180 351,401 251,410
-------- -------- --------
Deferred Tax Assets:
Reserve for Loan and Lease Losses 94,928 94,462 87,769
Federal Net Operating Loss Carryforward 46,815 109,482 36,044
Unrealized Loss on Investment Securities 43,473 23,414 53,150
Deferred Compensation 11,019 10,808 9,210
Other 32,680 20,020 24,335
-------- -------- --------
Total Deferred Tax Assets 228,915 258,186 210,508
-------- -------- --------
Net Deferred Tax Liabilities $126,265 $ 93,215 $ 40,902
======== ======== ========
NOTE 18 - EARNINGS PER SHARE: Basic earnings per share is calculated by dividing
net income, less dividend requirements on convertible preferred stock, by the
weighted average number of common shares outstanding for the period. Diluted
earnings per share takes into consideration the pro forma dilution assuming the
convertible preferred shares and the in-the-money outstanding stock options were
converted or exercised into common shares. It also takes into consideration the
dilutive impact of shares held in benefit plans and of forward purchase
contracts required to be settled in Provident Stock. Net income is not adjusted
for preferred dividend requirements.
Stock options to purchase approximately 2.4 million, 4.6 million and 5.1 million
shares of Common Stock were outstanding at December 31, 2003, 2002 and 2001,
respectively, but were not included in the computation of diluted earnings per
share because the options' exercise price was not in-the-money and, therefore,
the effect would be anti-dilutive.
78
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table sets forth the computation of basic and diluted earnings per
common share:
Year Ended December 31,
--------------------------------
(In Thousands Except Per Share Data) 2003 2002 2001
- ----------------------------------------------------------------- --------- --------- ---------
Basic:
Income Before Cumulative Effect of Changes in
Accounting Principles $ 97,902 $ 95,451 $ (1,003)
Less Preferred Stock Dividends (949) (949) (949)
-------- -------- --------
Income Available to Common Shareholders Before
Cumulative Effect of Changes in Accounting Principles 96,953 94,502 (1,952)
Cumulative Effect of Changes in Accounting Principles (1,202) -- --
-------- -------- --------
Net Income Available to Common Shareholders 95,751 94,502 (1,952)
Weighted-Average Common Shares Outstanding 48,830 48,806 49,011
-------- -------- --------
Basic Earnings (Loss) Per Share:
Before Cumulative Effect of Changes in Accounting Principles $ 1.99 $ 1.94 $ (0.04)
======== ======== ========
After Cumulative Effect of Changes in Accounting Principles $ 1.96 $ 1.94 $ (0.04)
======== ======== ========
Diluted:
Income Before Cumulative Effect of Changes in
Accounting Principles $ 97,902 $ 95,451 $ (1,003)
Less Preferred Stock Dividends (1) n/a n/a (949)
-------- -------- --------
Income Available to Common Shareholders Before
Cumulative Effect of Changes in Accounting Principles 97,902 95,451 (1,952)
Cumulative Effect of Changes in Accounting Principles (1,202) -- --
-------- -------- --------
Net Income Available to Common Shareholders 96,700 95,451 (1,952)
Weighted-Average Common Shares Outstanding 48,830 48,806 49,011
Benefit Plans Common Shares 710 497 --
Assumed Conversion of:
Convertible Preferred Stock (1) 988 988 n/a
Dilutive Stock Options (1) 364 452 n/a
Dilutive Impact of PRIDES Securities 57 -- --
-------- -------- --------
Dilutive Potential Common Shares 50,949 50,743 49,011
-------- -------- --------
Diluted Earnings (Loss) Per Share:
Before Cumulative Effect of Changes in Accounting Principles 1.92 1.88 (0.04)
======== ======== ========
After Cumulative Effect of Changes in Accounting Principles 1.90 1.88 (0.04)
======== ======== ========
(1) The conversion of preferred securities and stock options were not included
in the diluted earnings (loss) per share calculation for 2001 as these are
anti-dilutive.
NOTE 19 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES: Provident uses
derivative instruments to manage its interest rate risk. These instruments
include interest rate swaps and interest rate caps. In addition, forward
delivery commitments are entered to assist with the issuance of mortgage-backed
securities.
Interest rate swaps are agreements between two parties to exchange periodic
interest payments that are calculated on a notional principal amount. Provident
enters into swaps to synthetically alter the repricing characteristics of
specific assets, liabilities and off-balance sheet loan securitizations. As only
interest payments are exchanged, cash requirements and credit risk are
significantly less than the notional amounts.
Interest rate caps protect against the impact of rising interest rates on
interest-bearing financial instruments. When interest rates go above a cap's
strike rate, the cap provides for receipt of payments based on its notional
amount.
Interest rate derivative instruments have a credit risk component based on the
ability of a counterparty to meet the obligations to Provident under the terms
of the instruments. Notional principal amounts express the volume of the
transactions, but Provident's potential exposure to credit risk is limited only
to the market value of the instruments. Provident manages its credit risk in
these instruments through counterparty credit policies. At December 31, 2003,
Provident had bilateral collateral agreements in place
79
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
with its counterparties, against which Provident has pledged investment
securities with a carrying value of $102 million as collateral. There were no
past due amounts on any instruments as of December 31, 2003. Provident has never
experienced a credit loss related to these instruments.
Provident adopted the provisions of Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities," on January 1, 2001. Pursuant to
Statement 133, derivatives are carried at fair value and are recorded within
Other Assets or Accrued Interest and Other Liabilities in the balance sheet. The
accounting for the gain or loss resulting from the change in fair value depends
on the intended use of the derivative. For a derivative used to hedge changes in
fair value of a recognized asset or liability, or an unrecognized firm
commitment, the gain or loss on the derivative will be recognized in earnings
together with the offsetting loss or gain on the hedged item. This results in
earnings recognition only to the extent that the hedge is ineffective in
achieving offsetting changes in fair value. For a derivative used to hedge
changes in cash flows associated with forecasted transactions, the gain or loss
on the effective portion of the derivative will be deferred and reported as
accumulated other comprehensive income, a component of shareholders' equity,
until such time the hedged transaction affects earnings. For derivative
instruments not accounted for as hedges, changes in fair value are required to
be recognized in earnings.
Fair Value Hedging Strategy: Provident uses interest rate swaps to assist in the
management of its interest rate risk. The interest rate swaps effectively modify
Provident's exposure to interest rate risk by converting fixed rate liabilities,
generally time deposits and long-term debt, to a floating rate. These interest
rate swaps involve the receipt of fixed rate amounts in exchange for floating
rate interest payments over the life of the agreements without an exchange of
the underlying principal amounts.
As the changes in fair value of the hedged items offset the changes in fair
value of the derivatives, no material gain or loss has been recognized in 2003,
2002 or 2001.
Cash Flow Hedging Strategy: Provident has also entered into interest rate swap
agreements to reduce the impact of interest rate changes on future interest
payments of on and off-balance sheet financing. These interest rate swaps
convert floating rate debt to a fixed rate basis. These interest rate swaps have
generally been used to hedge interest payments involving floating rate debt and
off-balance sheet securitization transactions with maturities up to December
2014.
For the years ended December 31, 2003 and 2002, Provident recorded gains of
$29.8 million and $2.8 million, respectively, in accumulated other comprehensive
income. No significant gains or losses were recognized during 2003, 2002 or 2001
as a result of ineffective cash flow hedges. During the next twelve months,
management expects to reclassify $33.4 million of net losses on derivative
instruments from accumulated other comprehensive income to earnings which it
believes will be offset by improved cash flows of the hedged items associated
with these derivative instruments.
80
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of the notional amount of the interest rate derivatives at December 31
is as follows:
Interest Rate Swaps
---------------------
Interest Rate Caps
Receive Pay -----------------------
(In Millions) Fixed Fixed Purchased Sold
- ------------------------------- ------ ------ --------- ------
At December 31, 2003:
Certificates of Deposit $4,302 $ -- $ -- $ --
Long-Term / Subordinated Debt 1,047 498 1,010 1,010
Off-Balance Sheet Securitizations 59 671 1,510 1,510
Premium Index Deposits -- 195 -- --
Loans -- 66 -- --
For Customers' Purposes -- 59 45 --
------ ------ ------ ------
Totals $5,408 $1,489 $2,565 $2,520
====== ====== ====== ======
At December 31, 2002:
Certificates of Deposit $2,812 $ -- $ -- $ --
Long-Term / Subordinated Debt 838 622 1,010 1,010
Off-Balance Sheet Securitizations 139 1,265 1,736 1,736
Premium Index Deposits -- 195 -- --
Loans -- 51 -- --
For Customers' Purposes -- 37 13 --
------ ------ ------ ------
Totals $3,789 $2,170 $2,759 $2,746
====== ====== ====== ======
Summary information with respect to the interest rate derivatives used to manage
Provident's interest rate sensitivity at December 31, 2003 follows:
Interest Rate Swaps
-----------------------------
Interest Rate Caps
Receive Pay -------------------------------
(Dollars in Millions) Fixed Fixed Purchased Sold
- ---------------------------------------------------------- --------------- -------------- -------------- --------------
Notional Amount $ 5,408 $ 1,489 $ 2,565 $ 2,520
Positive Fair Value Adjustment 75 -- 29 --
Negative Fair Value Adjustment (50) (88) -- (29)
Weighted Average:
Receive Rate 5.07% 1.26% n/a n/a
Pay Rate 1.50% 6.02% n/a n/a
Strike Rate n/a n/a 8.97% 8.98%
Life (in years) 9.6 5.8 11.1 11.3
The expected notional maturities of Provident's interest rate derivative
portfolio at December 31, 2003 are as follows:
Interest Rate Swaps
------------------------------
Interest Rate Caps
Receive Pay ----------------------------------------------
(In Millions) Fixed Fixed Purchased Sold Total
- ------------------------------------------ -------------- -------------- -------------- ------------- --------------
Less than 1 Year $ 509 $ 195 $ 12 $ -- $ 716
From 1 to 5 Years 1,685 454 33 -- 2,172
From 5 to 10 Years 899 672 -- -- 1,571
From 10 to 15 Years 1,291 154 2,520 2,520 6,485
More than 15 Years 1,024 14 -- -- 1,038
------- ------- ------- ------- -------
Total $ 5,408 $ 1,489 $ 2,565 $ 2,520 $11,982
======= ======= ======= ======= =======
Provident also enters into forward delivery contracts for the future delivery of
commercial real estate and residential mortgage loans at a specified interest
rate to reduce the interest rate risk associated with loans held for sale. As of
December 31, 2003, Provident had $74 million in forward delivery contracts.
81
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 - CREDIT RISK TRANSFER INSTRUMENTS, CREDIT COMMITMENTS AND GUARANTEES:
During 2001 and 2000, Provident entered into two credit risk transfer
transactions related to its auto lease originations. Both transactions are
designed to reduce Provident's exposure to credit losses. Under the 2000
transaction, Provident transferred a substantial part of credit-related losses,
beyond a retained first loss piece, related to the then outstanding auto lease
pool. Similarly, the 2001 transaction enabled Provident to transfer a large
portion of its credit risk exposure related to its auto lease pool originated
during that year. As a result of these transactions, Provident was able to lower
its credit concentration in auto leasing while reducing its regulatory capital
requirements. As of December 31, 2003, the remaining unpaid auto lease balances
on the 2001 and 2000 credit risk transfer transactions were $0.4 billion and
$0.6 billion, respectively.
Commitments to extend credit are financial instruments in which Provident agrees
to provide financing to customers based on predetermined terms and conditions.
Since many of the commitments to extend credit are expected to expire without
being drawn upon, the total commitment amounts do not necessarily represent
future cash requirements. Provident evaluates each customer's creditworthiness
on a case-by-case basis. The amount of collateral obtained if deemed necessary
by Provident upon extension of credit is based on management's credit evaluation
of the counterparty. Collateral held varies but may include accounts receivable,
inventory, property, plant and equipment, and income-producing commercial
properties.
A standby letter of credit is an irrevocable guarantee whereby Provident
guarantees the performance of a customer to a third party in a borrowing
arrangement. They are primarily issued to support public and private borrowing
arrangements, including commercial paper, bond financing, and similar
transactions. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
Collateral is obtained based on management's credit assessment of the customer.
Generally, Provident issues standby letters of credit for terms from six months
to three years. As of December 31, 2003 and 2002, the carrying value of the
guarantee liability related to the standby letters of credit was $1.1 million
and $1.2 million, respectively.
Provident's commitments to extend credit and letters of credit which are not
reflected in the balance sheet at December 31 are as follows:
(In Millions) 2003 2002
- ------------------------------ ------ ------
Commitments to Extend Credit $4,633 $2,887
Standby Letters of Credit 248 274
Commercial Letters of Credit 3 11
Provident Bank has issued a guarantee for Red Mortgage to assist in its business
activities. This guarantee was made to Fannie Mae. Red Mortgage is an approved
Fannie Mae Delegated Underwriting and Servicing (DUS) mortgage lender. Under the
Fannie Mae DUS program, Red Mortgage underwrites, funds and sells mortgage loans
on multifamily rental projects. Red Mortgage then services these mortgage loans
on Fannie Mae's behalf. Participation in the Fannie Mae DUS program requires Red
Mortgage to share the risk of loan losses with Fannie Mae. Under the loss
sharing arrangement, Red Mortgage and Fannie Mae split losses with one-third of
all losses assumed by Red Mortgage and two-thirds of all losses assumed by
Fannie Mae. For Red Mortgage to
82
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
participate in the Fannie Mae DUS program, Provident Bank provided a guarantee
to Fannie Mae that it would fulfill all payments required of Red Mortgage under
the loss sharing arrangement if Red Mortgage fails to meet its obligations. As
of December 31, 2003, Red Mortgage serviced loans with outstanding principal
balances aggregating $3.8 billion under the DUS program. The guarantee will
continue until such time as the loss sharing agreement is amended or Red
Mortgage no longer shares the risk of losses with Fannie Mae. The fair value of
the guarantee, in the form of reserves for losses under the Fannie Mae DUS
program, has been established on Red Mortgage's balance sheet.
NOTE 21 - LINE OF BUSINESS REPORTING: Provident's three major business lines,
referred to as Commercial Banking, Retail Banking and Mortgage Banking, are
based on the products and services offered. Commercial Banking offers a broad
range of commercial lending and financial products and services to corporate
businesses. Retail Banking provides consumer lending, deposit accounts, trust,
brokerage and investment products and services to consumers and small
businesses. Mortgage Banking offers conforming and nonconforming residential
loans to consumers, and also provides fee-based loan processing, loan
warehousing and servicing for third party originators.
Financial results are determined based on an assignment of balance sheet and
income statement items to each business line. Equity allocations are made based
on various risk measurements of the business line. A matched funded transfer
pricing process is used to allocate interest income and expense among the
business lines. Provision for loan and lease losses is charged to each business
line based on its level of net charge-offs and the size and risk of its lending
portfolio. Activity-based costing is used to allocate expenses for centrally
provided services.
83
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Condensed income statements and total assets are provided below for Provident's
three major lines of business for the past three years. Corporate Center
includes revenues and expenses not allocated to the primary business lines,
including any item not related to their operating activity. The net loss of $8.3
million for 2003 and net income of $1.2 million for 2002 resulted from the
following actions taken by management: the sale of subprime loans, Merchant
Services, Florida assets and liabilities, and classified loans and aircraft
leases; the early retirement of higher interest rate debt; contract termination,
severance and business exit costs; and the impairment of equity investments and
aircraft lease residuals. Corporate Center also includes realized gains on
security sales and certain warrant gains.
Commercial Retail Mortgage Corporate
(In Millions) Banking Banking Banking Center Total
--------- --------- --------- --------- ---------
Year Ended December 31, 2003:
Net Interest Income $ 191.3 $ 63.6 $ 60.9 $ -- $ 315.8
Provision for Loan Losses (39.8) (8.8) (9.2) (58.2) (116.0)
Noninterest Income 186.2 512.1 49.6 97.4 845.3
Noninterest Expense (234.9) (527.9) (87.4) (51.7) (901.9)
Income Taxes (33.4) (12.7) (4.6) 4.2 (46.5)
--------- --------- --------- --------- ---------
Net Income $ 69.4 $ 26.3 $ 9.3 $ (8.3) $ 96.7
========= ========= ========= ========= =========
Total Assets $ 7,390 $ 4,610 $ 789 $ 4,229 $ 17,018
========= ========= ========= ========= =========
Year Ended December 31, 2002:
Net Interest Income $ 216.7 $ 32.6 $ 66.3 $ -- $ 315.6
Provision for Loan Losses (62.0) (8.0) (20.6) (9.0) (99.6)
Noninterest Income 150.0 603.6 41.1 10.8 805.5
Noninterest Expense (216.9) (586.8) (72.3) -- (876.0)
Income Taxes (30.1) (14.3) (5.0) (.6) (50.0)
--------- --------- --------- --------- ---------
Net Income $ 57.7 $ 27.1 $ 9.5 $ 1.2 $ 95.5
========= ========= ========= ========= =========
Total Assets $ 7,554 $ 4,854 $ 1,646 $ 3,486 $ 17,540
========= ========= ========= ========= =========
Year Ended December 31, 2001:
Net Interest Income $ 206.7 $ 3.4 $ 60.4 $ -- $ 270.5
Provision for Loan Losses (155.9) (27.9) (31.7) -- (215.5)
Noninterest Income 166.8 563.5 26.1 -- 756.4
Noninterest Expense (218.9) (529.4) (64.7) -- (813.0)
Income Taxes .5 (3.6) 3.7 -- .6
--------- --------- --------- --------- ---------
Net Income $ (0.8) $ 6.0 $ (6.2) $ -- $ (1.0)
========= ========= ========= ========= =========
Total Assets $ 7,115 $ 4,785 $ 1,799 $ 2,862 $ 16,561
========= ========= ========= ========= =========
NOTE 22 - TRANSACTIONS WITH AFFILIATES: At December 31, 2003, Carl H. Lindner,
Jr., members of his immediate family and trusts for their benefit, owned 42% of
American Financial Group's Common Stock. This group, along with entities
controlled by them, or established for their benefit, owned 42% of Provident's
Common Stock at year-end 2003. Provident leases its home office space and other
office space from a trust, for the benefit of a subsidiary of American Financial
Group. Rentals and renovations charged by American Financial Group and
affiliates for the years ended December 31, 2003, 2002 and 2001 amounted to $3.3
million, $3.8 million and $3.1 million, respectively. Provident paid $184,000,
$612,000 and $0 to a subsidiary of American Financial Group for insurance
coverage during 2003, 2002, and 2001, respectively. Payments of $0, $114,000 and
$28,000 were made to American Financial Group and affiliates for record
retention services for the years ended December 31, 2003, 2002 and 2001,
respectively. Approximately $100,000 was also paid to American Financial Group
for guard services in each of the past three years. During 2003, Provident paid
$871,000 to the Cincinnati Reds
84
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for advertising, tickets and suite rental. Carl H. Lindner, Jr. is chief
executive officer and part owner of the Reds. During 2003, 2002 and 2001,
Provident received $270,000, $150,000 and $245,000, respectively, from American
Financial Group in connection with an expense sharing arrangement for a
cafeteria operated by Provident for the employees of both companies. In 2003,
Provident received a loan payment and fees of $3,442,000 from a customer as a
result of an investment in preferred stock and warrants for common stock of the
customer by AFG.
Provident has had certain transactions with various executive officers,
directors and principal holders of equity securities of Provident and its
subsidiaries and entities in which these individuals are principal owners.
Various loans and leases have been made as well as the sale of commercial paper
and repurchase agreements to these persons. Such loans and leases to these
persons aggregated approximately $27.6 million and $25.6 million at December 31,
2003 and 2002, respectively. During 2003, new loans and leases aggregating $14.2
million were made to such parties and loans and leases aggregating $12.2 million
were repaid. All of the loans and leases were made at market interest rates and,
in the opinion of management, all amounts are fully collectible. At December 31,
2003 and 2002, these persons held Provident's commercial paper amounting to $0.4
million and $17.3 million, respectively. Additionally, repurchase agreements in
the amount of $14.2 million and $5.8 million had been sold to these persons at
December 31, 2003 and 2002, respectively. All of these transactions were at
market interest rates.
85
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 23 - FAIR VALUE OF FINANCIAL INSTRUMENTS: Carrying values and estimated
fair values for certain financial instruments as of December 31 are shown in the
following table. In cases where quoted market prices are not available, fair
values are based on estimates using present value or other valuation techniques.
Those techniques are significantly affected by the assumptions used, including
the discount rate and estimates of future cash flows. Because no secondary
market exists for many of Provident's assets and liabilities, the derived fair
values are calculated estimates, and the fair values provided herein do not
necessarily represent the actual values which may be realized in the disposition
of these instruments. The aggregate fair value amounts presented do not
represent the underlying value of Provident. What is presented below is a
point-in-time valuation that is affected, in part, by unrealized gains and
losses resulting from management's implementation of its program to manage
overall interest rate risk. It is not management's intention to immediately
dispose of a significant portion of its financial instruments. As a result, the
following fair value information should not be interpreted as a forecast of
future earnings and cash flows.
2003 2002
------------------------------- -------------------------------
Carrying Fair Carrying Fair
(In Thousands) Value Value Value Value
- ---------------------------- ------------ ------------ ------------ ------------
Financial Assets:
Cash and Cash Equivalents $ 526,572 $ 526,572 $ 540,919 $ 540,919
Trading Account Securities 119,646 119,646 127,848 127,848
Loans Held for Sale 595,505 595,505 436,884 436,884
Investment Securities 4,527,912 4,527,912 4,215,238 4,215,238
Loans and Leases 8,895,530 8,898,690 9,133,795 9,184,892
Less: Reserve for Losses (160,000) -- (201,051) --
------------ ------------ ------------ ------------
Net Loans and Leases 8,735,530 8,898,690 8,932,744 9,184,892
Financial Liabilities:
Deposits 10,335,718 10,204,765 9,848,979 9,818,970
Short-Term Debt 1,443,438 1,443,438 1,925,005 1,925,005
Long-Term Debt and Junior
Subordinated Debentures 3,764,729 3,973,023 4,293,731 4,447,041
Standby and Commercial
Letters of Credit 1,128 1,128 1,188 1,188
Derivative Instruments:
Interest Rate Swaps (62,877) (62,877) 7,985 7,985
Interest Rate Caps 49 49 -- --
The following methods and assumptions were used by Provident in estimating its
fair value disclosures for financial instruments:
- - Cash and cash equivalents: The carrying amounts reported in the balance
sheet for cash and short-term instruments approximate those assets'
fair values.
- - Trading account securities and investment securities: Fair values for
trading account securities and investment securities are based on
quoted market prices, where available. If quoted market prices are not
available, fair values are based on quoted market prices of comparable
instruments. Retained interest in securitized assets are valued using
discounted cash flow techniques. Significant assumptions used in the
valuation are presented in Note 3.
- - Loans and leases: For variable-rate loans that reprice frequently and
with no significant change in credit risk, fair values are based on
carrying values. The fair values for certain residential mortgage loans
and other consumer loans are based on quoted market prices of similar
loans sold in conjunction with securitization transactions, adjusted
for differences in loan characteristics. The fair values for other
loans and leases are estimated using discounted cash flow analyses and
interest rates currently being offered for loans and leases with
similar terms to borrowers of
86
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
similar credit quality. The fair values disclosed for loans held for
sale are equal to their carrying amounts.
- - Deposits: The fair values disclosed for demand deposits are equal to
their carrying amounts. The carrying amounts for variable-rate,
fixed-term money market accounts and certificates of deposit
approximate their fair values at the reporting date. Fair values for
fixed-rate certificates of deposit are estimated using a discounted
cash flow calculation that applies interest rates currently being
offered on certificates to a schedule of aggregated expected monthly
maturities on time deposits.
- - Short-term debt: The carrying amounts of federal funds purchased,
borrowings under repurchase agreements, and other short-term borrowings
approximate their fair values.
- - Long-term debt and junior subordinated debentures: The fair values of
long-term borrowings that are traded in the markets are equal to their
quoted market prices. The fair values of other long-term borrowings
(other than deposits) are estimated using discounted cash flow
analyses, based on Provident's current incremental borrowing rates for
similar types of borrowing arrangements.
- - Derivative instruments: The fair value of derivative instruments has
been recognized as either assets or liabilities in the balance sheet in
accordance to Statement No. 133, "Accounting for Derivative Instruments
and Hedging Activities." The fair value of derivative instruments is
based upon current market quotes.
NOTE 24 - SUBSEQUENT EVENT: On February 17, 2004, Provident announced that it
had signed a definitive agreement to merge with National City Corporation.
National City Corporation is a financial holding company headquartered in
Cleveland, Ohio. Under terms of the agreement, Provident shareholders will
receive 1.135 shares of National City Corporation common stock for each share of
Provident common stock in a tax-free exchange. Subject to regulatory and
stockholder approvals, the transaction is expected to close in the second
quarter of 2004.
NOTE 25 - ADDITIONAL INFORMATION:
LEGAL MATTERS: Provident and its subsidiaries are not parties to any pending
legal proceedings other than routine litigation incidental to their business
except for the following matters related to the restatements announced March 5,
2003, and April 15, 2003. The restatement of previously reported operating
results announced on March 5, 2003, was attributed to unintentional errors in
the accounting for nine auto lease financing transactions originated between
1997 and 1999.
Provident's audit committee, through legal counsel, engaged the auditing firm of
PricewaterhouseCoopers LLP for the purpose of conducting a review of the
Company's March 5, 2003 restatement. Provident's management affirmed, based upon
the review of its advisors, its prior conclusion that the accounting errors that
led to the restatement were unintentional.
Several purported class-actions were filed against Provident, its President,
Robert L. Hoverson, its Chief Financial Officer, Christopher J. Carey, and their
predecessors in those positions, on behalf of all purchasers of Provident
securities from March 30, 1998 through March 5, 2003. Litigation was also filed
against Provident, its President, Robert L. Hoverson and its Chief Financial
Officer, Christopher J. Carey plus PFGI Capital Corporation, a Provident
subsidiary, and others on behalf of all purchasers of PRIDES in
87
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
or traceable to a June 6, 2002 offering of those securities registered with the
Securities and Exchange Commission and extending to March 5, 2003. That action
alleges violations of securities laws by the defendants in Provident's financial
disclosures during the period from March 30, 1998 through March 5, 2003 and in
the June 2002 offering. These actions are based upon circumstances involved in
the restatement of earnings announced by Provident on March 5, 2003 and allege
violations of federal securities laws by the defendants in Provident's financial
disclosures during the period from March 30, 1998 through March 5, 2003. They
seek an unspecified amount of damages and, in two cases, reimbursement of all
executive bonuses received during that period.
These actions were consolidated before Judge S. Arthur Spiegel of the United
States District Court for the Southern District of Ohio under the caption,
Merzin v. Provident Financial Group, Inc., consolidated Civil Action Master File
No. C-1-03-165. The Amended Consolidated Complaint was filed on August 22, 2003.
Provident and the other Defendants filed a Motion to Dismiss the Complaint on
November 5, 2003. The motion was granted on March 9, 2004 and the Court
dismissed all claims except those relating to the June 6, 2002 offering of
6,600,000 PRIDE securities. However, the Court's order confined any later
finding of damages to $0.70 per PRIDE security.
Several derivative actions have also been filed in federal and state courts on
behalf of Provident versus Provident's directors and others. These suits were
also concerned with the restatements of earnings and allege that the defendants
breached fiduciary duties owed to Provident and are responsible for the
conditions that led to the restatements and failed to ensure that the accounting
errors were prevented or detected. These actions seek recovery from the
defendants of an unspecified amount of damages and reimbursement of all
executive bonuses and stock options.
The derivative actions filed in federal court are pending before Chief Judge
Walter Herbert Rice of the United States District Court for the Southern
District of Ohio under the captions, Plumbers & Pipefitters Local 572 Pension
Fund v. Jack Cook, et al., Case No. C-1-03-168, and Peter Berg v. Jack M. Cook,
et al., Case No. C-1-03-196. Motions to dismiss the federal court derivative
actions were filed on behalf of all of the defendants on September 2, 2003.
Plaintiffs have opposed the motions. All proceedings in the derivative actions
filed in state court have been indefinitely stayed by agreement of the parties
and their respective legal counsel.
RESTRICTIONS ON CASH AND NONINTEREST BEARING DEPOSITS: Federal Reserve Board
regulations require that Provident Bank maintain certain minimum reserve
balances. The average amount of those reserve balances for the year ended
December 31, 2003, was approximately $82.6 million.
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
RESTRICTED ASSETS: Provident formed the subsidiaries listed below to account for
and support the process of transferring, securitizing and/or selling of vehicle
and equipment leases. These subsidiaries are separate legal entities and each
maintains books and records with respect to its assets and liabilities. The
assets of these subsidiaries, which are included in the consolidated financial
statements, are not available to secure financing or otherwise satisfy claims of
creditors of Provident or any of its other subsidiaries.
The subsidiaries and their total assets as of December 31, 2003 and 2002 follow
(in thousands):
December 31,
----------------------
Subsidiary 2003 2002
- ---------------------------------------- -------- --------
Provident Auto Rental LLC 1999-1 $660,794 $723,901
Provident Auto Leasing Company 479,968 617,371
Provident Auto Rental LLC 2000-1 329,150 350,500
Provident Auto Rental LLC 2001-1 281,887 314,339
Provident Auto Rental LLC 2000-2 141,139 150,401
Provident Auto Rental Company LLC 1998-2 130,889 152,986
Provident Auto Rental Company LLC 1998-1 124,199 141,300
Provident Lease Receivables Company LLC 78,476 115,460
The above amounts include items which are eliminated in the Consolidated
Financial Statements.
RESTRICTIONS ON TRANSFER OF FUNDS FROM SUBSIDIARIES TO PARENT: The transfer of
funds by Provident Bank to the parent as dividends, loans or advances is subject
to various laws and regulations that limit the amount of such transfers. The
amount of dividends available for payment in 2004 by Provident Bank to the
parent company is approximately $95.1 million, plus 2004 net income. Pursuant to
Federal Reserve and State regulations, the maximum amount available to be loaned
to affiliates (as defined), including its Parent, by Provident Bank, was
approximately $162.8 million to any single affiliate, and $325.7 million to all
affiliates combined of which $70.4 million was loaned at December 31, 2003.
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PARENT COMPANY FINANCIAL INFORMATION: Parent Company only condensed financial
information for Provident Financial Group, Inc. is as follows:
BALANCE SHEETS (PARENT ONLY)
December 31,
--------------------------
(In Thousands) 2003 2002
- --------------------------------------------- ---------- ----------
ASSETS
Cash and Cash Equivalents $ 265,070 $ 243,000
Trading Account Securities 12,065 10,470
Investment Securities Available for Sale 278,762 299,024
Investment in Subsidiaries:
Banking 1,063,164 1,056,278
Non-Banking 17,753 18,287
Accounts Receivable from Banking Subsidiaries 28,266 18,552
Other Assets 86,873 103,222
---------- ----------
TOTAL ASSETS $1,751,953 $1,748,833
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts Payable and Accrued Expenses $ 50,927 $ 56,575
Commercial Paper 261,053 271,269
Long-Term Debt and
Junior Subordinated Debentures 540,919 540,618
---------- ----------
Total Liabilities 852,899 868,462
Shareholders' Equity 899,054 880,371
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,751,953 $1,748,833
========== ==========
STATEMENTS OF INCOME (PARENT ONLY)
Year Ended December 31,
-------------------------------------
(In Thousands) 2003 2002 2001
- ------------------------------------------- -------- -------- --------
Income:
Dividends from Banking Subsidiaries $ 65,000 $ 45,000 $ 15,000
Interest Income from Banking Subsidiaries 24,169 25,394 24,944
Other Interest Income 538 1,261 1,469
Noninterest Income (11,453) 1,080 7,492
-------- -------- --------
78,254 72,735 48,905
Expenses:
Interest Expense 29,229 32,125 40,762
Noninterest Expense 6,962 1,705 2,842
-------- -------- --------
36,191 33,830 43,604
-------- -------- --------
Income Before Taxes and Equity in Undistributed
Net Income of Subsidiaries 42,063 38,905 5,301
Applicable Income Tax Credits 10,141 5,571 7,936
-------- -------- --------
Income Before Equity in Undistributed Net Income
of Subsidiaries 52,204 44,476 13,237
Equity in Undistributed Net Income of Subsidiaries 44,496 50,975 (14,240)
-------- -------- --------
Net Income (Loss) $ 96,700 $ 95,451 $ (1,003)
======== ======== ========
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
STATEMENTS OF CASH FLOWS (PARENT ONLY)
Year Ended December 31,
-----------------------------------------
(In Thousands) 2003 2002 2001
- ------------------------------------------- --------- --------- ---------
Operating Activities:
Net Income (Loss) $ 96,700 $ 95,451 $ (1,003)
Adjustment to Reconcile Net Income to Net Cash
Provided by (Used in) Operating Activities:
Equity in Undistributed Net Income
of Subsidiaries (44,496) (50,975) 14,240
Amortization and Accretion 821 453 1,066
Tax Benefit Received from Exercise
of Stock Options 1,570 1,069 2,706
Expensing of Stock Option Grants 1,259 -- --
Realized Investment Security (Gains) Losses 13,860 11 (72)
(Increase) Decrease in Interest Receivable (18) (48) 177
(Increase) Decrease in Other Assets 1,047 (22,754) 3,783
Increase (Decrease) in Interest Payable 1,070 1,163 (261)
Decrease in Other Liabilities (6,934) (15,584) (20,821)
--------- --------- ---------
Net Cash Provided by (Used In)
Operating Activities 64,879 8,786 (185)
--------- --------- ---------
Investing Activities:
Investment Securities Available for Sale:
Proceeds from Sales 10,960 24,159 19,379
Proceeds from Maturities and Prepayments 5,806 11,664 15,234
Purchases (3,655) (19,883) (50,671)
--------- --------- ---------
Net Cash Provided by (Used In)
Investing Activities 13,111 15,940 (16,058)
--------- --------- ---------
Financing Activities:
Net Increase (Decrease) in Commercial Paper (10,216) 30,698 53,481
Principal Payments on Long-Term Debt (120) (120) (391)
Proceeds from Issuance of Long-Term Debt and
Junior Subordinated Debentures -- 75,000 124,432
Cash Dividends Paid (48,503) (48,334) (48,002)
Repurchase of Common Stock -- (24) (246)
Proceeds from Exercise of Stock Options 6,362 4,232 3,884
Contribution to Subsidiaries (3,443) (346) (54,986)
Net Increase in Other Equity Items -- -- 903
--------- --------- ---------
Net Cash Provided by (Used In)
Financing Activities (55,920) 61,106 79,075
--------- --------- ---------
Increase in Cash and Cash Equivalents 22,070 85,832 62,832
Cash and Cash Equivalents at Beginning of Year 243,000 157,168 94,336
--------- --------- ---------
Cash and Cash Equivalents at End of Year $ 265,070 $ 243,000 $ 157,168
========= ========= =========
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SUPPLEMENTARY DATA
Quarterly Consolidated Results of Operations - (Unaudited)
The following are quarterly consolidated results of operations for the two years
ended December 31, 2003.
Fourth Third Second First
(In Thousands Except Per Share Data) Quarter Quarter Quarter Quarter
- ----------------------------------------- --------- --------- --------- ---------
2003:
Total Interest Income $ 174,777 $ 182,786 $ 198,253 $ 201,742
Total Interest Expense (100,561) (108,663) (113,759) (118,783)
--------- --------- --------- ---------
Net Interest Income 74,216 74,123 84,494 82,959
Provision for Loan and Lease Losses (35,070) (11,919) (52,469) (16,521)
--------- --------- --------- ---------
Net Interest Income After Provision
for Loan and Lease Losses 39,146 62,204 32,025 66,438
Noninterest Income 253,557 185,471 212,974 193,287
Noninterest Expense (246,274) (207,291) (225,294) (221,196)
--------- --------- --------- ---------
Income (Loss) Before Income Taxes and
Cumulative Effect of Changes in
Accounting Principles 46,429 40,384 19,705 38,529
Applicable Income Taxes (15,005) (12,923) (6,502) (12,715)
--------- --------- --------- ---------
Income (Loss) Before Cumulative Effect of
Changes in Accounting Principles 31,424 27,461 13,203 25,814
Cumulative Effect of Changes in
Accounting Principles (1,202) -- -- --
--------- --------- --------- ---------
Net Income $ 30,222 $ 27,461 $ 13,203 $ 25,814
========= ========= ========= =========
Net Earnings Per Common Share:
Before Cumulative Effect of Changes in
Accounting Principles:
Basic $ .63 $ .56 $ .27 $ .52
Diluted .61 .54 .26 .51
After Cumulative Effect of Changes in
Accounting Principles:
Basic $ .61 $ .56 $ .27 $ .52
Diluted .59 .54 .26 .51
Cash Dividends .24 .24 .24 .24
2002:
Total Interest Income $ 208,391 $ 208,250 $ 211,331 $ 213,416
Total Interest Expense (127,482) (130,624) (132,603) (135,121)
--------- --------- --------- ---------
Net Interest Income 80,909 77,626 78,728 78,295
Provision for Loan and Lease Losses (18,237) (23,532) (33,575) (24,205)
--------- --------- --------- ---------
Net Interest Income After Provision
for Loan and Lease Losses 62,672 54,094 45,153 54,090
Noninterest Income 204,287 198,397 206,578 196,230
Noninterest Expense (226,700) (216,079) (216,637) (216,612)
--------- --------- --------- ---------
Income Before Income Taxes 40,259 36,412 35,094 33,708
Applicable Income Taxes (13,630) (12,376) (11,924) (12,092)
--------- --------- --------- ---------
Net Income $ 26,629 $ 24,036 $ 23,170 $ 21,616
========= ========= ========= =========
Net Earnings Per Common Share:
Basic $ .54 $ .49 $ .47 $ .43
Diluted .52 .47 .46 .43
Cash Dividends .24 .24 .24 .24
Quarterly earnings per share numbers do not necessarily add to the year-to-date
amounts due to rounding.
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the participation of
management, including the principal executive and financial officers, of the
effectiveness of the design and operation of Provident's disclosure controls and
procedures as of December 31, 2003. Based on that evaluation, management,
including the principal executive and financial officers, concluded that
Provident's disclosure controls and procedures were effective with no
significant weaknesses noted. There has been no change in Provident's internal
control over financial reporting that occurred during Provident's quarter ended
December 31, 2003 that has materially affected, or is reasonably likely to
materially affect, Provident's internal control over financial reporting.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following are Provident's directors and executive officers:
Jack M. Cook has been a director since 1992. Since 2002, Mr. Cook has been
associated with Compass Group, Inc. and Breakout Solutions, L.L.C., healthcare
consulting companies. In April of 2001, Mr. Cook retired as President and Chief
Executive Officer of Health Alliance of Greater Cincinnati, which includes
Christ, University, Fort Hamilton, Jewish and St. Luke Hospitals. Mr. Cook
serves on the Audit and Nominating Committees. Age: 59
Thomas D. Grote, Jr. has been a director since 1991. Mr. Grote has been
President of Grote Enterprises, LLC, a management consulting firm providing
consulting services to the construction and real estate industries, since
January, 1998. Mr. Grote serves on the Audit, Compensation and Nominating
Committees. Age: 48
Robert L. Hoverson has been a director since 1998. Mr. Hoverson has been
President and Chief Executive Officer of Provident and The Provident Bank since
May, 1998. Mr. Hoverson was Senior Vice President of Provident from August, 1992
to May, 1998, and was Executive Vice President of The Provident Bank from
September, 1985 to May, 1998. Mr. Hoverson serves as Chairman of the Executive
Committee. Age: 61
Joseph A. Pedoto has been a director since 1980. Mr. Pedoto has been President
of JLM Financial, Inc., a financial consulting firm, since 1990. Mr. Pedoto
serves on the Executive and Nominating Committees and is Chairman of the
Compensation Committee. Mr. Pedoto's service as a Director of Provident was
interrupted from September, 1991 to August, 1993. Age: 61
Sidney A. Peerless has been a director since 1980. Dr. Peerless is a retired
physician and surgeon specializing in diseases of the ear, nose and throat. Dr.
Peerless is Chief Emeritus of the Otolaryngology Department of The Jewish
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
Hospital, Cincinnati, Ohio. Dr. Peerless serves on the Compensation and
Nominating Committees. Age: 82
Joseph A. Steger has been a director since 1992. Dr. Steger is the President
Emeritus of the University of Cincinnati, having served as President of the
University from 1984 to October of 2003. He also serves as a Director of
Milacron, Inc. Dr. Steger serves as Chairman of the Audit Committee and on the
Executive and Nominating Committees. Age: 67
Christopher J. Carey joined Provident as Executive Vice President and Chief
Financial Officer on November 19, 1998. For the five-year period prior to
joining Provident, Mr. Carey served as Senior Vice President and Controller of
Corestates Financial Corp. and Chief Financial Officer of Corestates Bank. Age:
49
James L. Gertie joined Provident on December 10, 2001 as Executive Vice
President and Chief Credit and Risk Officer of The Provident Bank. He has served
as Executive Vice President and Chief Credit and Risk Officer of Provident since
April 25, 2002. Prior to joining Provident, Mr. Gertie served as Executive
Credit Officer-Debt and Equity Capital Markets and Portfolio Management of
FleetBoston Financial Corporation from September of 1999 to December 2001 and
Director-Risk Management, Risk Measurement, Information, Analysis and Capital
Markets for BankBoston Corporation from April of 1995 to September of 1999. Age:
47
Anthony M. Stollings has served as Controller and Chief Accounting Officer of
Provident since July of 2002. He has been Controller since October of 1991,
Senior Vice President since August of 1998 and Chief Accounting Officer since
December 2002 of The Provident Bank. Age: 49
James R. Whitaker joined Provident as Vice President, General Counsel and
Assistant Secretary on December 2, 2002. For the five-year period prior to
joining Provident, Mr. Whitaker was a partner in the Cincinnati, Ohio law firm
of Keating, Muething & Klekamp, P.L.L. Age: 57
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires Provident's
executive officers, directors and persons who own more than 10% of a registered
class of Provident's equity securities to file reports of ownership and changes
in ownership. Based on a review of the copies of such forms and written
representations received by it, Provident believes that during the last fiscal
year, all of its executive officers, directors and ten percent stockholders
complied with the Section 16(a) reporting requirements with the exception that
Messrs. Carey, Gertie, Hoverson and Stollings each failed to timely file one
report involving the purchase of 20, 61, 65 and 4 shares, respectively, by the
Deferred Compensation Plan Trustee, which purchases were not reported to them in
a timely manner by the Trustee. In addition, Mr. Hoverson also failed to timely
file one report involving the purchase of 125 shares for his minor son on August
30, 2000.
CORPORATE GOVERNANCE
Provident's Board has established an Audit Committee composed of three members,
namely, Jack M. Cook, Thomas D. Grote, Jr. and Joseph A. Steger,
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
each of whom meet the requirements for Audit Committee members established by
the Securities Exchange Act of 1934 and Nasdaq listing standards.
Provident's Board has determined that Directors Cook and Steger are audit
committee financial experts under rules issued by the Securities and Exchange
Commission.
Provident's Board of Directors has established a Nominating Committee whose
function is to consider and nominate persons for election to Provident's Board
of Directors. The nominating Committee is composed of Messrs. Cook, Grote,
Pedoto, Peerless and Steger each of whom meet the independence requirements for
members established by Nasdaq. The Nominating Committee will consider
recommendations by security holders. Shareholders desiring to submit
recommendations for nominations by the Committee should direct them in care of
Provident's Secretary at the address on the cover page of this report. The
recommendation should include relevant information concerning the qualifications
of the person recommended. The Committee will evaluate these recommendations in
the same manner as any others received.
Provident's Board has also established a Compensation Committee composed of
Messrs. Pedoto, Grote and Peerless, each of whom meet the requirements for
independence established by Nasdaq listing standards. The Committee's activities
are described in the Compensation Committee report contained in Item 11.
Provident has adopted a Code of Ethics and Business Conduct that applies to its
CEO, CFO, principal accounting officer and persons performing similar functions
and undertakes to provide a copy of such Code of Ethics to any person without
charge, upon written request to Provident's Secretary at the address on the
cover page of this report.
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
Annual Compensation
--------------------------------
Securities All Other
Underlying Compensation
Salary Bonus Options (1)
Name and Principal Position Year ($) ($) (#) ($)
- ----------------------------------------- ---- ------- ------- ---------- ------------
Robert L. Hoverson 2003 664,262 425,000 90,000 44,280
President and Chief Executive Officer (2) 2002 640,985 400,000 200,000 48,053
2001 616,154 0 90,000 47,396
Christopher J. Carey 2003 353,736 265,000 50,000 26,259
Executive Vice President and Chief 2002 317,391 240,000 70,000 31,377
Financial Officer (2) 2001 305,154 180,000 30,000 39,084
James L. Gertie(3), Executive Vice 2003 358,462 335,000 50,000 28,738
President and Chief Credit and Risk 2002 350,000 300,000 0 144,008
Officer (2)
Anthony M. Stollings, Controller and 2003 179,154 35,000 5,000 12,487
Chief Accounting Officer (2) 2002 159,148 55,000 10,000 12,491
James R. Whitaker, Vice President and 2003 250,000 150,000 0 0
General Counsel (2)
(1) For 2003, Messrs. Hoverson, Carey, Gertie and Stollings each received
contributions of $8,179, pursuant to the Provident Retirement Plan.
Employer contributions made pursuant to other benefit plans were as
follows: 401(k) Plan: Messrs. Hoverson, Carey, Gertie and Stollings,
$3,000; the Excess Benefit Deferred Compensation Plan: Mr. Hoverson,
$28,765; Mr. Carey, $12,806; Mr. Gertie, $9,755; and Mr. Stollings,
$1,097; the Deferred Compensation Plan: Mr. Hoverson, $4,336; Mr. Carey,
$2,274; Mr. Gertie, 7,804; and Mr. Stollings, $210.
(2) Messrs. Hoverson, Carey, Gertie, Stollings and Whitaker entered into
executive retention agreements with Provident in February of 2004. These
agreements provide that if, during the one-year period following a change
in control of Provident, the executive's employment is terminated without
cause (as defined in the agreement) or he terminates his employment for
reason (as defined in the agreement) he will receive:
96
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
- base salary up to the date of termination and any previously
deferred compensation and accrued vacation pay;
- a severance amount equal to the sum of (i) his highest base salary
during the 12 month period prior to the change in control and during
the 12 month period prior to his date of termination and (ii) his
highest bonus paid during the 3 calendar years prior to the change
in control times a multiplier; and
- continued health insurance coverage and other benefits for a
specified period following the date of termination.
For Messrs. Hoverson, Carey, Gertie and Whitaker, the multiplier is 3.0
and each will receive health insurance and other benefits for 36 months
following the date of termination. For Mr. Stollings the multiplier is 2.0
and he will receive health insurance and other benefits for 24 months
following the date of termination.
In addition, Messrs. Hoverson, Carey, Gertie and Whitaker will be credited
with three years of additional service for purposes of Provident's
Supplemental Executive Retirement Plan.
For Messrs. Hoverson, Carey and Whitaker, a merger in which Provident is
not the surviving entity is deemed to constitute "good reason" within the
meaning of the agreement and therefore the foregoing benefits will be paid
if such person terminates his employment during the one-year period
following a merger.
If the payments of the benefits described above to any of the executives
described above constitute a "parachute payment" under Sections 280G and
4999 of the Internal Revenue Code, the surviving company will be obligated
to pay to each such executive a lump sum cash payment sufficient to put
each of them in the same net after-tax position he would have been in had
the benefit not been subject to the excise tax under Section 4999.
OPTION GRANTS IN LAST FISCAL YEAR
% of Total
Number of Options Market Grant
Securities Granted to Price on Date
Underlying Employees Exercise Grant Present
Options in Fiscal Price Date Expiration Value($)
Name Granted(1) 2003 ($/Share) ($/Share) Date (2)
- -------------------- ---------- ---------- --------- --------- ---------- --------
Robert L. Hoverson 90,000 7.93% 27.66 27.66 2/9/13 581,598
Christopher J. Carey 50,000 4.41% 27.66 27.66 2/9/13 323,110
James L. Gertie 50,000 4.41% 27.66 27.66 2/9/13 323,110
Anthony M. Stollings 5,000 0.44% 27.66 27.66 2/9/13 32,311
(1) The right to exercise the options shown vests at 20% per year.
97
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
(2) Valued using the Black-Scholes option pricing model. The assumptions used
for the variables in the model were: risk-free interest rate of 3.45%,
dividend yield of 3.50%, volatility factor of 29.10% and an expected life of
the option of 7 years.
FISCAL 2003 OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES
Value of Unexercised
Shares In-the-Money Options at
Acquired Value Underlying Unexercised FY-End
On Realized Options at FY-End Exercisable/Unexercisable
Name Exercise ($) Exercisable/Unexercisable ($)
- --------------------- -------- -------- ------------------------- -------------------------
Robert L. Hoverson 22,500 386,100 438,000/349,000 1,888,128/2,130,860
Christopher J. Carey 0 0 84,000/136,000 222,980/ 827,420
James L. Gertie 0 0 40,000/110,000 346,434/ 735,652
Anthony M. Stollings 0 0 19,250/ 18,000 64,160/ 108,232
James R. Whitaker 0 0 6,000/ 24,000 36,060/ 144,240
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
Pension Plan Table
-------------------------------------------------------------------
Years of Service
-------------------------------------------------------------------
Remuneration 5 10 15 20 25
- ------------ ------- ------- ------- ------- -------
$ 50,000 $22,500 $45,000 $52,500 $60,000 $67,500
250,000 37,500 75,000 87,500 100,000 112,500
400,000 60,000 120,000 140,000 160,000 180,000
500,000 75,000 150,000 175,000 200,000 225,000
600,000 90,000 180,000 210,000 240,000 270,000
800,000 120,000 240,000 280,000 320,000 360,000
1,000,000 150,000 300,000 350,000 400,000 450,000
1,200,000 180,000 360,000 420,000 480,000 540,000
1,400,000 210,000 420,000 490,000 560,000 630,000
1,600,000 240,000 480,000 560,000 640,000 720,000
In November, 1993, the Board of Directors adopted a Supplemental Executive
Retirement Plan ("SERP") to provide a supplemental retirement benefit to key
management or highly compensated employees of the Company who may be designated
from time to time by the Compensation Committee.
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
The purpose of the SERP is to assure that each participant receives an annual
retirement benefit starting at age 65, based on years of service, of up to 50%
of the average of his or her highest five years' annual compensation (which
relates to the salary and bonus columns of the Summary Compensation Table in
Item 11) during the ten years preceding the participant's retirement,
disability, termination of employment or removal from the SERP. When a
participant retires, or if a participant's employment is terminated or a change
in control occurs, the SERP benefit is calculated, and then funds from the
following sources are deducted to determine the payment due from the Company
under the SERP; (i) one half of the participant's monthly social security
insurance benefit (except if there is a change in control) and (ii) the
participant's accrued benefits attributable to employer contributions to the
Company's Employee Stock Ownership Plan, 401 (k) Plan, Excess Benefit Plan,
Deferred Compensation Plan, Profit Sharing Plan and any other qualified or
non-qualified pension or deferred compensation plans maintained by the Company.
If the sum of these payments exceeds the participant's benefit computed under
the SERP, then no payment will be due from the Company under the SERP.
The table above shows the assumed actuarial value of the retirement plan
benefits plus the SERP payment which, when taken together, will result in a
total retirement payment based on average compensation and years of service.
Assuming retirement at age 65, the number of years of service for the
individuals named in the Summary Compensation Table participating in the SERP
would be: Christopher J. Carey, 21 years; James L. Gertie, 20 years; Robert L.
Hoverson, 22 years; and James R. Whitaker, 10 years. Assuming a change in
control during June of 2004, the number of years of service for the individuals
named in the Summary Compensation Table participating in the SERP would be:
Christopher J. Carey, 9 years; James L. Gertie, 6 years; Robert L. Hoverson, 22
years; and James R. Whitaker, 5 years.
DIRECTOR COMPENSATION
Non-employee directors receive $25,000 per year for serving as a director and as
a member of committees of the Board. They also receive $1,500 for each Board
meeting attended and $1,000 for each committee meeting attended, with committee
chairs receiving $2,000 for each committee meeting. Directors who are employees
of Provident are not separately compensated for serving as directors.
Non-employee directors may postpone the receipt of from 5% to 100% of their
Board compensation. Amounts deferred may be invested in a Provident Common Stock
Account, in which case the Account is credited annually with a percentage of
Provident's pre-tax earnings per share for each share of Provident Common stock
in the Account, with the percentage to be credited depending upon Provident's
return on equity.
Each non-employee director is also granted a non-qualified option to purchase
2,000 shares of Common Stock at the time of election or re-election to the Board
of Directors, with the exercise price being the average of the closing bid and
ask prices on the last trading date immediately prior to the date of grant.
Non-employee directors with ten years of service as a director receive annual
retirement benefits equal to the fees paid during the 12 months immediately
preceding the retirement date, with payments to commence at retirement or 65th
birthday, whichever is later. Retirement benefits will be paid for a period of
years equal to the number of the director's years of service, divided by three.
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
The Compensation Committee of the Board of Directors establishes salaries,
bonuses and stock option awards for executive officers on an annual basis. The
Committee's policy is to encourage and motivate Provident's executive officers
to achieve both short-term and long-term business, financial and community
goals, and thereby build shareholder value on a steady basis. The Committee
believes it is important to provide competitive levels of compensation that will
enable Provident to attract and retain the most qualified executives and to
provide incentive plans that emphasize stock ownership, thus aligning more
closely the interests of management with those of shareholders.
The Committee has established three primary components which it utilizes in
setting annual compensation levels, namely:
- - Base Compensation
- - Annual Bonuses
- - Stock Option Grants
In establishing compensation levels for 2003, the Committee utilized executive
compensation surveys which the Committee believes are appropriate and an
analysis prepared by compensation consultants to the Committee. In addition, the
Committee reviewed compensation levels for financial institutions of similar
asset size.
Compensation in excess of $1,000,000 per year paid to the Chief Executive
Officer of a company as well as to each of the other executive officers listed
in the compensation table is not deductible for Federal income tax purposes
unless it is "performance-based" and approved by shareholders. The Committee
does not believe these limitations should interfere with the application of
policies which guide its compensation decisions.
Base Compensation
In establishing base salaries for 2003 the Committee took into account each
particular executive officer's level of responsibility and potential for future
responsibilities, salary levels of competitors for similar functions and
Provident's performance for 2002. The Committee also took into account the
recommendations of the President for executive officers other than himself in
establishing base salaries.
Bonuses and Stock Options
Bonuses for 2003 were based on the Committee's review of bonus awards paid by
the financial institutions included in the surveys, the Committee's evaluation
of Provident's performance and the relative contributions to that performance by
the executive officers to whom bonuses were awarded and recommendations made by
the President. While the bonus awards were based on Provident's performance,
they were not tied to specific performance objectives.
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
Awards of stock options are made by the Committee to motivate long-term future
performance and as a reward for past performance, consistent with the purposes
set forth in Provident's 1997 Stock Option Plan.
Chief Executive Officer
In determining the compensation paid to Robert L. Hoverson, who served as
Provident's President and Chief Executive Officer in 2003, the Committee
utilized each of the components described above for executive officers. In this
regard, the Committee established Mr. Hoverson's salary level for 2003 based on
its evaluation of not only Provident's financial performance, but also on the
Committee's evaluation of Mr. Hoverson's strategic and leadership abilities in
planning for and leading Provident during 2002. The Committee similarly made its
own evaluation of Mr. Hoverson's contributions to Provident on a subjective
basis in establishing the amount of his bonus payment and stock option awards.
While the compensation for Mr. Hoverson was based on Provident's performance, it
was not tied to specific performance objectives.
Compensation Committee:
Joseph A. Pedoto, Chairman
Thomas D. Grote, Jr.
Sidney A. Peerless
FINANCIAL PERFORMANCE
The graph below summarizes the cumulative return experienced by Provident's
shareholders over the years 1998 through 2003, compared to the Nasdaq Index and
the Keefe, Bruyette & Woods 50 Bank Index which is a market-capitalization
weighted bank stock index that includes all money-center banks and most major
regional bank holding companies, and is a widely available index. The number of
companies comprising the KBW 50 Index allows ready comparisons of Provident's
stock with an industry standard. Provident is not included in the KBW 50 Index.
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
TOTAL RETURN ANALYSIS
PROVIDENT FINANCIAL GROUP VS. MARKET INDICES
(LINE GRAPH)
Peer Group is Comprised of Institutions Represented in the Keefe, Bruyette and
Woods 50 Bank Index
1998 1999 2000 2001 2002 2003
---- ---- ---- ---- ---- ----
Provident Financial Group $100 $ 97 $104 $ 77 $ 79 $ 97
Nasdaq Market Index 100 185 112 89 61 92
Peer Group 100 97 116 111 103 138
102
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
PRINCIPAL SHAREHOLDERS
The following persons are the only shareholders known by Provident to own
beneficially more than 5% of its outstanding Common Stock as of February 20,
2004:
Amount and Nature
of
Name and Address of Beneficial Percent of Class
Beneficial Owner (a) Ownership (g)
- -------------------------------------- ----------------- ----------------
American Financial Group, Inc. ("AFG") 7,117,675 (b) 14.2
Carl H. Lindner 2,268,642 (c) 4.6
Carl H. Lindner III 3,042,576 (d) 6.2
S. Craig Lindner 3,437,500 (e) 7.0
Keith E. Lindner 3,473,548 (f) 7.1
(a) The address of each of these parties is One East Fourth Street,
Cincinnati, Ohio 45202.
(b) Includes 6,129,475 shares held by AFG subsidiaries and 988,200 shares
issuable upon conversion of Provident's Series D Convertible Preferred
stock held by an AFG subsidiary. AFG has agreed with the Board of
Governors of the Federal Reserve System not to exercise voting control
over more than 4.9% of Provident's voting shares. As a result, the number
of shares of Provident Common Stock beneficially owned by AFG, and which
exceed 4.9% of Provident's outstanding voting shares, have been voted in
strict proportion with all other (non-AFG held) outstanding Provident
voting shares.
(c) Includes 1,729,844 shares held by his spouse and 391,242 shares held by a
foundation over which he has voting and dispositive power. Excludes
1,130,183 shares held in a trust for the benefit of his family for which a
third party acts as trustee with voting and dispositive power.
(d) Includes 8,285 shares held by his spouse individually or as trustee.
Includes 56,064 shares held by one of his children and 1,160,802 shares
which are held in various trusts for the benefit of his children for which
Keith E. Lindner acts as trustee with voting and dispositive power.
(e) Includes 51,700 shares held by his spouse individually or as trustee,
181,480 shares held by his spouse as custodian for their children and
35,126 shares held by a foundation over which he has voting and
dispositive power. Includes 181,480 shares held by two of his children and
50,000 shares which are held in trusts for the benefit of his children for
which Keith E. Lindner acts as trustee with voting and dispositive power.
Also includes 1,315,794 shares held in two trusts for the benefit of his
family for which third parties hold voting power.
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
Excludes 7,900 shares held in a trust for the benefit of his family for
which a third party acts as a trustee with voting and dispositive power.
(f) Includes 3,433 shares held in trust for the benefit of his spouse, 681
shares held by his spouse individually, 27,008 shares he holds as
custodian for his children and 340,381 shares held in trusts for the
benefit of his children, over which he or his spouse have shared voting
and dispositive power. This number excludes 1,210,802 shares (described in
footnotes (d) and (e) above), which are held in trusts for the benefit of
the children of his brothers, Carl H. Lindner III and S. Craig Lindner
over which Keith E. Lindner has voting and dispositive power but no
financial interest. Also includes 1,050,819 shares held in a trust for the
benefit of his family for which a third party acts as a trustee with
voting power.
(g) The percentages of outstanding shares of Common Stock beneficially owned
(within the meaning of Rule 13d-3 under the Securities Exchange Act of
1934) by Carl H. Lindner III, S. Craig Lindner and Keith E. Lindner are
3.8%, 6.9% and 9.5%, respectively, after attributing the shares held in
various trusts for the benefit of the children of Carl H. Lindner III and
S. Craig Lindner (for which Keith E. Lindner acts as trustee with voting
and dispositive power) to Keith E. Lindner.
DIRECTORS AND EXECUTIVE OFFICERS
This table lists the executive officers and directors of Provident and shows how
much common stock each owned on February 20, 2004. Except as described in the
footnotes to the table, each person has sole investment and voting power over
the shares shown.
Common Stock
Beneficially Owned
-------------------------------
Percent of
Name Position Amount (1) Class(2)
- -------------------------- ---------------------------------------------------- ---------- -----------
Robert L. Hoverson President, Chief Executive Officer and Director 777,152 1.6%
Jack M. Cook Director 22,320 *
Thomas D. Grote, Jr. Director 24,206 *
Joseph A. Pedoto Director 40,873 *
Sidney A. Peerless Director 47,799 *
Joseph A. Steger Director 22,201 *
Christopher J. Carey Executive Vice President and Chief Financial 138,695 *
Officer
James L. Gertie Executive Vice President and Chief Credit and Risk 58,316 *
Officer
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
Common Stock
Beneficially Owned
-------------------------------
Percent of
Name Position Amount (1) Class(2)
- -------------------------- ---------------------------------------------------- ---------- -----------
Anthony M. Stollings Controller and Chief Accounting Officer 43,151 *
James R. Whitaker Vice President and General Counsel 8,145 *
All Directors and Executive
Officers as a Group 1,182,858 2.4%
(1) Including options to purchase common stock currently exercisable or
exercisable within 60 days from February 20, 2004 as follows: Mr.
Hoverson, 543,000 shares; Mr. Carey, 120,000 shares; Mr. Cook, 13,500
shares; Mr. Gertie, 50,000 shares; Mr. Grote, 15,570 shares; Mr. Pedoto,
15,750 shares; Dr. Peerless, 13,500 shares; Dr. Steger, 15,750 shares; Mr.
Stollings, 24,850 shares; and Mr. Whitaker, 6,000 shares. Includes shares
held in Provident's 401(k) Plan, Deferred Compensation Plan and Outside
Director Deferred Compensation Plan, over which such persons do not have
voting power, collectively, as follows: Mr. Hoverson, 91,144 shares; Mr.
Carey, 13,958 shares; Mr. Gertie, 5,218 shares; Mr. Stollings, 11,674
shares; Mr. Whitaker, 995 shares; Mr. Cook, 7,133 shares; Mr. Grote, 4,364
shares; Mr. Pedoto, 1,857 shares; Dr. Steger, 4,983 shares.
(2) Ownership of less than 1% is indicated by an asterisk (*).
105
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
DECEMBER 31, 2003 EQUITY COMPENSATION PLAN INFORMATION
Number of
securities to be Future issuance
issued upon Weighted-average under equity
exercise of exercise price compensation
outstanding of outstanding plan (excluding
options, options, securities
warrants and warrants and reflected in
rights rights column (a))
Plan Category (a) (b) (c)
- ---------------------------------- ---------------- ---------------- ---------------
Equity compensation plans approved 7,254,207 $29.49 1,927,638 (2)
by security holders(1)
Equity compensation plans not 957,410 $28.20 395,436 (4)
approved by security holders(3)
Total 8,211,617 $29.33 2,323,074
(1) 1988 Stock Option Plan
1992 Outside Directors' Stock Option Plan
1997 Stock Option Plan
1993 Deferred Compensation Plan
(2) The number of shares available for future issuance under the 1993 Deferred
Compensation Plan depends on levels of participation in the Plan and on
the investment elections by the participants.
(3) 1996 Non-Executive Officer Stock Option Plan. Provides for the grant of
stock options to employees of Provident, other than executive officers.
Options are granted at an exercise price not less than 95% of fair market
value at the time of grant, for a term of up to 10 years. Options vest as
determined by the Compensation Committee. 216,700 options outstanding.
2000 Employee Stock Option Plan. Provides for the grant of stock options
to employees of Provident, other than executive officers. The Plan has
been used to grant options to all employees of Provident who have not
received options under other Provident stock option plans. Options are
granted at an exercise price of not less than 95% of fair market value at
the time of grant, for a term of up to 10 years. Options vest as
determined by the Compensation Committee. 667,980 options outstanding.
2002 Outside Directors Stock Option Plan. Provides for the automatic grant
of 2,000 options to each non-employee director upon election to the Board
and upon each subsequent annual election. The options are granted at an
exercise price equal to fair market value, for a term of 10 years and vest
six months after the date of grant. 20,000 options outstanding.
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
1997 Fidelity Financial of Ohio Stock Option Plan. Assumed by Provident in
the February 2000 acquisition of Fidelity Financial of Ohio, Inc. No
further options may be granted under this plan. Outstanding options were
granted at fair market value, having a term of 10 years and vested 20%
annually. 1,028 options outstanding.
Excess Benefit Deferred Compensation Plan. Provides for the contribution
by Provident for each participant of the amount that could not be
contributed for such participant to the Provident Retirement Plan because
such contribution would have resulted in a violation of Section 415(c) or
401(a)(17) of the Internal Revenue Code. Amounts contributed to the Plan
are invested as directed by the participant. 25,258 Provident common
shares are held in the Plan.
Outside Directors Deferred Compensation Plan. Outside directors may defer
up to 100% of their Board fees. Amounts deferred are invested either in
Provident common stock or other investments chosen by the director.
Provident common shares held in the Plan are credited annually with a
percentage of Provident's pre-tax earnings per share for the first four
years such shares are held in the Plan, with the percentage credited
depending on Provident's return on equity. 21,444 Provident common shares
are held in the Plan.
(4) 191,000 shares remain available for issuance under the 1996 Non-Executive
Officer Stock Option Plan. 195,880 shares remain available for issuance
under the 2000 Employee Stock Option Plan. 5,000 shares remain available
for future issuance under the 2002 Outside Directors Stock Option Plan.
3,556 shares remain available for future issuance under the Outside
Directors Deferred Compensation Plan. The number of shares available for
issuance under the Excess Benefit Deferred Compensation Plan depends on
the investment elections by the participants.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Provident and its subsidiaries, in their normal course of business have had, and
to the extent permitted by applicable regulations and other regulatory
restrictions expect to continue to have, transactions with Provident's
directors, officers, principal shareholders and affiliates of such persons
including American Financial Group, Inc. ("AFG") and its subsidiaries. All such
transactions are and will be on terms no less favorable to Provident than those
which could be obtained with non-affiliated parties.
In 2003, Provident received $270,000 from AFG in connection with an expense
sharing arrangement for a cafeteria operated by Provident for the employees of
both companies. AFG provides security guard and surveillance services at
Provident's main office for which Provident was charged $100,000 in 2003. In
2003, AFG provided property and liability insurance for which Provident was
charged $184,000. Provident leases its main banking and corporate offices from a
trust for the benefit of a subsidiary of AFG. Provident was charged rent under
the leases of $3,254,000 in 2003. During 2003, Provident paid $871,000 to the
Cincinnati Reds for advertising, tickets and suite rental. Carl H. Lindner is
chief executive officer and part owner of the Reds.
Certain of the principal shareholders, directors and executive officers of
Provident maintain investments in Provident commercial paper and repurchase
107
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
agreements. The average month-end commercial paper balances for such persons
(including commercial paper held by corporations they control, members of their
immediate families and trusts for their benefit) for 2003 were as follows: Carl
H. Lindner, $3,309,000; Keith E. Lindner, $1,603,000; and siblings of Carl H.
Lindner, $399,000. The average repurchase agreement balances for such persons
for 2003 were as follows: AFG, $6,133,000.
Loans and lines of credit were extended by Provident Bank in 2003 to certain of
Provident's executive officers, directors, principal shareholders, affiliates of
such persons and to members of their families. Management believes that such
loans and lines of credit were made in the ordinary course of business, on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with other persons and do not
involve more than the normal risk of collectibility or present other unfavorable
features. During 2003, the highest month-end outstanding balances of loans to
principal shareholders of Provident and their related interests were as follows:
AFG, $1,136,000; Carl H. Lindner, $855,000; siblings of Carl H. Lindner,
$9,157,000; and S. Craig Lindner, $2,550,000. In addition, Provident Bank had
loans outstanding to three companies in which AFG or members of the Lindner
family held minority ownership interests during 2003. The highest month-end
outstanding balances of these loans during 2003 were $39,952,000.
In 2003, Provident received a loan payment and fees of $3,442,000 from a
customer as a result of an investment in preferred stock and warrants for common
stock of the customer by AFG.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Provident paid fees to Ernst & Young LLP during 2003 and 2002 as follows:
2002 2003
Audit Fees $576,000 $1,006,000
Audit Related Fees 535,000 190,000
Tax Fees 179,000 56,000
All Other Fees 136,000 7,000
Audit related fees include fees for audits of subsidiaries, audits of employee
benefit plans and consents and other procedures related to registration
statements filed by Provident. Tax fees include tax consulting services and tax
return review for Provident and its subsidiaries. All other fees relate to
accounting consultation for Provident. The Audit Committee has determined that
the provision of the foregoing non-audit services is compatible with maintaining
the independence of Ernst & Young LLP.
The Audit Committee has adopted policies that require its approval for any audit
and non-audit services to be provided to Provident. The Audit Committee
delegated authority to the members of the Committee to approve certain non-audit
services. Pursuant to these procedures and delegation of authority, the Audit
Committee was informed of and approved all of the audit and other services
described above. No services were provided with respect to the de minimus waiver
process provided by rules of the Securities and Exchange Commission.
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. See Index to Financial Statements on page 45 for a list of all
financial statements filed as a part of this report.
2. Schedules to the consolidated financial statements required by
Article 9 of Regulation S-X have been omitted as they are not
required, not applicable or the information required thereby is set
forth in the related financial statements.
3. Exhibits:
Number Exhibit Description Filing Status
------ ------------------- -------------
3.1 Articles of Incorporation Incorporated by reference to Form
10-Q for quarter ending June 30,
1997.
3.2 Code of Regulations Incorporated by reference to
Proxy Statement for the 1994
Annual Meeting of Shareholders.
4.1 Instruments defining the Provident has no outstanding
rights of security issue of indebtedness exceeding
holders 10% of the assets of Provident
Financial and Consolidated
Subsidiaries. A copy of the
instruments defining the rights
of security holders will be
furnished to the Commission
upon request.
4.2 Plan of Reorganization Incorporated by reference to Form
relating to Series D, 10-K for 1995.
Non-Voting Convertible
Preferred Stock
10.1 Junior Subordinated Incorporated by reference to
Indenture, dated as of Exhibit 4.1 on Form 8-K dated
November 27, 1996, between November 27, 1996.
Provident and the Bank
of New York, as Indenture
Trustee
10.2 Amended and Restated Incorporated by reference to
Declaration of Trust of Exhibit 4.3 on Form 8-K dated
Provident Capital Trust I, November 27, 1996.
dated as of November 27,
1996
10.3 Form of Guarantee Agreement Incorporated by reference to
entered into by Provident registration statement number
and The Bank of New York, 333-20769.
as Guarantee Trustee
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
Number Exhibit Description Filing Status
------ ------------------- -------------
10.4 Provident 1990 Employee Incorporated by reference to
Stock Purchase Plan(1) Post-Effective Amendment No. 1
to Form S-8 (File No. 33-34904).
10.5 Provident Retirement Plan Incorporated by reference to
(As amended)(1) Form S-8 (File No. 33-90792).
10.6 Provident 1992 Advisory Incorporated by reference to Form
Directors' Stock Option Plan 8-K filed October 22, 1992, and
(As amended)(1) Form S-8 (File No. 33-62707).
10.7 Provident 1992 Outside Incorporated by reference to Form
Directors' Stock Option S-8 (File No. 33-51230).
Plan(1)
10.8 Provident Restricted Incorporated by reference to Form
Stock Plan(1) S-2 (File No. 33-44641).
10.9 Registration of Preferred Incorporated by reference to Form
Capital Securities, between S-3 (File No. 333-80231).
Provident Capital Trust II,
Provident and Chase
Manhattan Bank
10.10 Agreement and Plan of Incorporated by reference to Form
Reorganization between S-4 (File No. 333-88723).
Provident and Fidelity
Financial of Ohio, Inc.
10.11 Registration of Preferred Incorporated by reference to Form
Capital Securities of S-3 as amended by Form S-3/A File
Provident Capital Trust No. 333-93603).
III and IV
10.12 Registration of Glenway Incorporated by reference to Form
Financial Corporation 1990 S-8 (File No. 333-96503) and Form
Stock Option and Incentive S-8 (File No. 333-55698).
Plan, Fidelity Federal Savings
Bank 1992 Stock Incentive
Plan, Fidelity Financial of
Ohio, Inc. 1997 Stock Option
Plan, and OHSL Financial Corp.
1992 Stock Option and
Incentive Plan
10.13 Separation agreement between Incorporated by reference to Form
Provident and Philip R. Myers 10-Q for the second quarter
(1) of 2001.
10.14 Provident Dividend Incorporated by reference to Form
Reinvestment Plan S-3 (File No. 333-67754).
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
Number Exhibit Description Filing Status
------ ------------------- -------------
10.15 Employment agreement between Incorporated by reference to Form
Provident and James L. Gertie 8-K (File No. 02672034).
(1)
10.16 Employment agreement between Incorporated by reference to
Provident and Christopher J. Form 10-K for 2002.
Carey(1)
10.17 Employment agreement between Incorporated by reference to
Provident and James R. Form 10-K for 2002.
Whitaker(1)
10.18 Provident 1988 Stock Option Incorporated by reference to.
Plan (As amended)(1) Form 10-K for 2002.
10.19 Provident 1996 Non-Executive Incorporated by reference to
Officer Stock Option Plan Form 10-K for 2002.
(As amended)(1)
10.20 Provident 1997 Stock Option Incorporated by reference to
Plan (As amended)(1) Form 10-K for 2002.
10.21 Provident 2000 Stock Option Incorporated by reference to
Plan (As amended)(1) Form 10-K for 2002.
10.22 Provident Deferred Incorporated by reference to
Compensation Plan (As Form 10-K for 2002.
Amended)(1)
10.23 Provident 2002 Outside Incorporated by reference to
Directors Stock Option Plan(1) Form 10-K for 2002.
10.24 Provident Outside Directors Incorporated by reference to
Deferred Compensation Plan Form 10-K for 2002.
(As Amended)(1)
10.25 Provident Supplemental Incorporated by reference to
Executive Retirement Plan Form 10-K for 2002.
(As Amended)(1)
10.26 Agreement and Plan of Merger Incorporated by reference to
By and Between National City Form 8-K filed by National
Corporation and Provident City Corporation on
Financial Group, Inc. Dated February 17, 2004.
As of February 16, 2004.
10.27 Employment agreement between Filed herewith.
Provident and Robert L.
Hoverson (1)
10.28 Employment agreement between Filed herewith.
Provident and Christopher J.
Carey (1)
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PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
Number Exhibit Description Filing Status
------ ------------------- -------------
10.29 Employment agreement between Filed herewith.
Provident and James R.
Whitaker(1)
10.30 Employment agreement between Filed herewith.
Provident and Anthony
Stollings (1)
10.31 Employment agreement between Filed herewith.
Provident and James L.
Gertie (1)
14 Code of Ethics Incorporated by reference to
the investor relations page
of Provident's web site at
http://www.providentbank.com.
21 Subsidiaries of Provident Filed herewith.
23 Consent of Independent Filed herewith.
Auditors
31.1 Rule 13a-14(a)/15d-14(a)
Certification of Principal Filed herewith.
Executive Officer
31.2 Rule 13a-14(a)/15d-14(a)
Certification of Principal Filed herewith.
Financial Officer
32.1 Section 1350
Certification of Principal Filed herewith.
Executive Officer
32.2 Section 1350
Certification of Principal Filed herewith.
Financial Officer
(1) Management Compensatory Agreements
112
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
(b) Reports on Form 8-K:
Form 8-K (Items 7 and 12) Earnings release for third quarter; filed on
October 15, 2003.
Form 8-K (Items 7 and 12) Slide show for third quarter investor conference
call; filed on October 16, 2003.
Form 8-K (Items 7 and 12) Earnings release for fourth quarter and full
year; filed on January 21, 2004.
Form 8-K (Items 7 and 12) Slide show for fourth quarter investor
conference call; filed on January 22, 2004.
Form 8-K (Items 5 and 7) Announcement of Plan of Merger between National
City Corporation and Provident Financial Group, Inc.; filed on February
17, 2004.
113
PROVIDENT FINANCIAL GROUP, INC. AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of
1934, Provident Financial Group, Inc. has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
Provident Financial Group, Inc.
/s/Robert L. Hoverson
-------------------------------
Robert L. Hoverson
President
March 12, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of Provident Financial
Group, Inc. and in the capacities and on the dates indicated.
Signature Capacity Date
- ----------------------- ----------------------------- --------------
/s/Robert L. Hoverson Director and President March 12, 2004
- ----------------------- (Principal Executive Officer)
Robert L. Hoverson
/s/Jack M. Cook Director March 12, 2004
- ------------------------
Jack M. Cook
/s/Thomas D. Grote, Jr. Director March 12, 2004
- -----------------------
Thomas D. Grote, Jr.
/s/Joseph A. Pedoto Director March 12, 2004
- -----------------------
Joseph A. Pedoto
/s/Joseph A. Steger Director March 12, 2004
- -----------------------
Joseph A. Steger
/s/Christopher J. Carey Executive Vice President March 12, 2004
- ----------------------- and Chief Financial Officer
Christopher J. Carey
114